Case File
efta-01415820DOJ Data Set 10OtherEFTA01415820
Date
Unknown
Source
DOJ Data Set 10
Reference
efta-01415820
Pages
222
Persons
0
Integrity
Extracted Text (OCR)
EFTA DisclosureText extracted via OCR from the original document. May contain errors from the scanning process.
31 October 2017
Railroads
Canadian Rails
Deutsche Bank
Markets Research
North America
Canada
Industrials
Railroads
Industry
Canadian Rails
Date
31 October 2017
Initiation of Coverage
Flipping the Script - Buy CP, Sell CNI
Seldon Clarke, CFA
Associate Analyst
Amit Mehrotra
Research Analyst
Kenya Watson
Research Associate
Chris Snyder, CFA
to
Initiating Coverage of Canadian Rails
We are expanding our coverage of Transportation companies with initiation of
coverage of the Canadian railroad industry. We are positive on Canadian
Pacific
(CP, Buy) and cautious on Canadian National (CNI, Sell), as we see overall
market
share and earnings trajectory driving a reversal in recent relative value
trends. All
told we forecast CP to grow EPS at double the rate of CNI (+30% for CP vs.
+15%
for CNI cumulatively through 2019), which together with capex and free cash
trends should drive re-rating at CP and de-rating for CNI. In this report we
present
a primer on the Canadian rail industry, with deep dives on Canadian Pacific
and
Canadian National.
Deutsche Bank Securities Inc.
Distributed on: 31/10/2017 20:03:27 GMT
Deutsche Bank does and seeks to do business with companies covered in its
research reports. Thus, investors should be
aware that the firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider
this report as only a single factor in making their investment decision.
DISCLOSURES AND ANALYST CERTIFICATIONS
EFTA01415820
ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017.
Obed7b6cfllc
EFTA01415821
EFTA01415822
Railroads
Canadian Rails
Deutsche Bank
Markets Research
North America
Canada
Industrials
Railroads
Industry
Canadian Rails
Date
31 October 2017
Initiation of Coverage
Flipping the Script - Buy CP, Sell CNI
Initiating Coverage of Canadian Rails
We are expanding our coverage of Transportation companies with initiation of
coverage of the Canadian railroad industry. We are positive on Canadian
Pacific
(CP, Buy) and cautious on Canadian National (CNI, Sell), as we see overall
market
share and earnings trajectory driving a reversal in recent relative value
trends. All
told we forecast CP to grow EPS at double the rate of CNI (+30% for CP vs.
+15%
for CNI cumulatively through 2019), which together with capex and free cash
trends should drive re-rating at CP and de-rating for CNI. In this report we
present
a primer on the Canadian rail industry, with deep dives on Canadian Pacific
and
Canadian National.
CANADIAN NATIONAL (CNI): A Victim of Its Own Success; Initiate Sell/$73 PT
We see 1096+ downside in CNI shares as the company's strong outperformance
starts to slow- driven by both the law of large numbers (the company already
achieves a mid 40's operating margin, up from the high 30's five years ago)
as
well as catch-up performance from CP. For example, we note that from
2012-2016
CNI increased volumes at more than double the rate of CP, reflecting mix as
well
as market share gains during CP's implementation of Precision Railroading.
The
combination of CNI's slower prospective earnings growth and high capex (20%
of
sales) implies 15.5x P/E under our DCF-derived methodology, implying
potential
for 3.5 turns (20%) valuation de-rating vs. current trading levels. Initiate
Sell.
CANADIAN PACIFIC (CP): Shifting Gears; Initiate Buy/$209 PT
Following its multi-year implementation of Precision Railroading, CP is
shifting
gears from cost take-out to top-line growth. As such, we see at least 15%
EFTA01415823
upside in shares as CP leverages its reduced cost base, improved service
levels,
and recent capacity investments to retake market share. We expect this to
translate to 30% cumulative EPS growth over the next two years, reflecting
midsingle
digit revenue growth, significant operating leverage, and accelerated share
repurchase. Against this backdrop we see CP's relative valuation discount as
unsustainable, which underpins our positive stance to shares. Initiate Buy.
Valuation and Risks:
We utilize P/E multiples to value rail stocks, with our target multiple
assumptions
heavily supported by our discounted cash flow models. Risks for the group
include
recession, industrial production, pricing, and mgmt. execution. For more
details
please company-specific CP and CNI sections within this note.
Seldon Clarke, CFA
Associate Analyst
Amit Mehrotra
Research Analyst
Kenya Watson
Research Associate
Chris Snyder, CFA
Research Associate
Companies featured
Canadian Pacific (CP.N),USD174.74
Canadian National (CNI.N),USD81.21
Buy
Sell
Deutsche Bank Securities Inc.
Deutsche Bank does and seeks to do business with companies covered in its
research reports. Thus, investors should be
aware that the firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider
this report as only a single factor in making their investment decision.
DISCLOSURES AND ANALYST CERTIFICATIONS
ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017.
EFTA01415824
31 October 2017
Railroads
Canadian Rails
Table Of Contents
Executive Summary
3
North American Railroads
10
Rail End Markets Overview and
Outlook
23
Railroad
Valuation
34
CP Company Overview
40
Management
Overview
48
Valuation
49
Financial
Statements
51
CNI Company Overview
56
Management
Overview
65
Valuation
65
Financial
Statements
67
Page 2
Deutsche Bank Securities Inc.
EFTA01415825
31 October 2017
Railroads
Canadian Rails
Executive Summary
We are expanding our coverage of Transportation companies with initiation of
coverage of the Canadian railroad industry. We are positive on Canadian
Pacific
(CP, Buy) and cautious on Canadian National (CNI, Sell), as we see overall
market
share and earnings trajectory driving a reversal in recent relative value
trends. All
told we forecast CP to grow EPS at double the rate of CNI (+30% for CP vs.
+15%
for CNI cumulatively through 2019), which together with capex and free cash
trends should drive re-rating at CP and de-rating for CNI. In this report we
present
a primer on the Canadian rail industry, with deep dives on Canadian Pacific
and
Canadian National.
We do not believe current valuation appropriately reflects the relative
earnings
trajectory and shifting market dynamics within the Canadian rail industry. We
believe CP is well positioned to regain market share from CNI as it leverages
its lowered cost base, improved service levels, and recent capacity
investments
to retake market share. In our view, these efforts will help CP achieve
industryleading
volume and earnings growth over the next several years (ex-CSX).
A lower cost base and better service levels should help CP regain share
From 2012-2016, CNI increased volumes (revenue ton-miles [RTM's]) at more
than
double the rate of CP (+3.0% CAGR vs. +1.2% CAGR for CP). While mix likely
played a factor, we believe the key driver behind this was CNI's ability to
win
market share as the lower-cost carrier with superior service. Further, this
came
at a transitional time for CP as the focus was largely on the implementation
of
Precision Railroading which likely pushed freight onto other transportation
modes
as well. As you can see below, CNI had nearly 18% points of cost advantage
over
CP (as measured by operating ratio) before CP began implementing Precision
Railroading in 2012. This advantage has largely been erased, and we expect
just
a 200bps difference in operating ratios in 2017.
Figure 1: Canadian RTM's 2004-2017E (2004=100)
100
110
120
130
EFTA01415826
140
80
90
137.5
CP RTM's
CNI RTM's
115.3
Figure 2: CNI's cost advantage has largely been erased
10%
12%
14%
16%
18%
20%
(2%)
0%
2%
4%
6%
8%
17.8%
14.2%
2.0%
0.8%
(0.0%)
Moreover, CP has seen a significant improvement in service levels while CNI's
service metrics are essentially inline with 2012 levels. Behind this
improvement
was CP's multi-year track upgrade program which was completed in 2015.
While a more efficient railroad, better service, and lower costs typically
all go
Deutsche Bank Securities Inc.
Page 3
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017E
CNI cost advantage vs. CP
2005
EFTA01415827
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017E
2018E
2019E
EFTA01415828
31 October 2017
Railroads
Canadian Rails
hand-in-hand, we believe it is important to note that almost all of CP's
service
improvements came after 2014, which is when the aforementioned volume trends
started to diverge.
Figure 3: CP's avg. train speed is up 28% since 2012 vs.
down 5% for CNI
15%
25%
35%
(15%)
(5%)
5%
2013 2014
CP
2015
2016
CNI
2017
Figure 4: CP's dwell has improved by 13% vs. just 1%
for CNI
10%
15%
20%
(15%)
(10%)
(5%)
0%
5%
2013 2014 2015 2016 2017
CP
CNI
We believe CP's improvements are beginning to manifest in volume trends. As
you can see below, volumes at CP have inflected positively relative to CNI in
recent months and appear to be gaining momentum. CP is still playing catchup
in Intermodal, though we note the majority of CNI's intermodal growth is
coming from International, which we believe carries a lower margin than
domestic
intermodal, which represents a bigger piece of the pie for CP. Looking out
over the
next couple of years, we expect this momentum to continue for CP and forecast
cumulative RTM growth of 7% by 2019 (vs. 2017) compared to 5% for CNI.
Figure 5: CP's volumes began outpacing CNI in recent
months
100
110
120
EFTA01415829
130
90
CP RTM's (ex-intermodal)
CNI RTM's (ex-intermodal)
Figure 6: and Intermodal volumes aren't far behind
100
110
120
130
140
90
CP Intermodal RTM's
CNI Intermodal RTM's
The picture becomes even clearer when we look at the number of carload
classifications growing relative to those declining on a yoy basis. As you
can see
below, CP's carload strength appears to be broad-based and gaining momentum.
Page 4
Deutsche Bank Securities Inc.
4-wk avg.( 100=Week 1 '17)
% chg. From 2012
Jan-17
Feb-17
Mar-17
Apr-17
May-17
Jun-17
Jul-17
Aug-17
Sep-17
Oct-17
28%
(5%)
4-wk avg.( 100=Week 1 '17)
Jan-17
Feb-17
Mar-17
Apr-17
May-17
Jun-17
Jul-17
Aug-17
Sep-17
Oct-17
% chg. From 2012
(13%)
(1%)
EFTA01415830
31 October 2017
Railroads
Canadian Rails
On the other hand, CNI's carload trends appear to be losing steam with
Intermodal
and "Other" being the only carload groupings up yoy over the past four weeks.
Figure 7: CP carload growth appears to be gaining
momentum...
Carloads growing YoY
Carloads declining YoY
2
7
4
5
2 2 2 2
7 7 7 7
4
5
2
7
4 3 4 3 3
5 6 5 6 6
5 6
4 3
8 7 6
1 2 3
4
5
6
3
8
1
6
2
3
7
Figure 8: as CNI's carload trajectory appears to be losing
steam
Carloads growing YoY
Carloads declining YoY
7 8 7 7 7 7 8
4
5
2 1
7 8 9 9
2 3 3 4
7 6 6 5
2 1 2 2 2 2 1
6 6
3 3
EFTA01415831
4 4
5 5
2
7
CP is putting the pieces together to leverage a better network
After building a better foundation, i.e. lower-cost base and better service,
CP has
begun putting the pieces together to profitably grow its revenue base. A key
piece,
in our view, was the appointment of John Brooks as CM0 in February, 2017. In
the
2.5 years prior to John's appointment as CMO, Keith Creel was largely
responsible
for overseeing sales and marketing at CP. At the same time, however, Creel
was
acting COO and being groomed to be Hunter Harrison's replacement. Combined
with the major task of turning around North America's least profitable
railroad, its
easy to see how marketing/sales efforts largely went by the wayside. In
addition
to John's appointment as CMO, these efforts have been reinvigorated through a
number of initiatives:
■
Trip Plan - Introduced in late 2016, Trip Plan allows customers to
track shipments on a car by car basis thereby eliminating inefficiencies
and increasing delivery accuracy. This service helped drive on-time
performance above 90% in 2016 (well above industry avg).
■
Enhanced intermodal offering - CP recently opened its transload facility
in Vancouver which helps steamship lines more efficiently manage their
containers. Transload facilities enable the interchange of commodities
to different rail cars / containers. This allows CP to utilize a steamship's
containers for inland originating traffic destined for ports, thereby
reducing costs to its customer by eliminating transportation costs
on empty containers. To this point, empty export containers out of
Vancouver are up over 40% ytd through September.
■
Expanding sales/marketing footprint - CP announced just last month
that it is expanding its sales and marketing presence in Asia. Positions
are being added in China and Singapore to expand business with
current customers and attract new ones. This follows a number of
other announcements over the past several months aimed at improving
CP's product/market reach through increased communication with its
customers.
■
Dedicated Train Program - Introduced during the 2014/15 crop year,
CP's Dedicated Train Program (DTP) allows its customers to control
Deutsche Bank Securities Inc.
Page 5
EFTA01415832
Jan-16
Mar-16
May-16
Jul-16
Sep-16
Nov-16
Jan-17
Mar-17
May-17
Jul-17
Sep-17
Jan-16
Mar-16
May-16
Jul-16
Sep-16
Nov-16
Jan-17
Mar-17
May-17
Jul-17
Sep-17
EFTA01415833
31 October 2017
Railroads
Canadian Rails
their own rail assets for a full crop year. This program helps customers
more efficiently manage their supply chains and demand for the service
continues to grow (up 15% yoy in 3Q).
While CNI has long been ahead of the curve in many of these efforts, we
believe
what will take place over the next several years is more of a natural shift
in market
share back to CP. Aside from service and cost, the major difference between
any
major Class I railroad is its geographical footprint. We believe much of the
market
share which CP lost to CNI over the past several years was simply due to the
fact
that CNI had a better overall service offering which in many cases outweighed
any advantage CP may have had geographically. Now that CP has eliminated any
service or cost advantage that CNI was able to take advantage of in the
past, we
expect to see a natural rebalancing of market share in CP's favor.
Relative valuation premium/discount expected to flip in coming years
With CNI still trading at a 7.5% premium to CP on a fwd. P/E basis, we
believe
current multiples imply that recent market share losses at CP are structural
and
will likely continue long-term. However, we believe CP is turning the corner
and
expect a natural rebalancing of rail business to support best-in-class volume
growth over the next several years. With much of this rebalancing coming at
the
expense of CNI, we expect the 10% premium that CNI has been trading at to
reverse over the next 12-14 months.
Figure 9: CP NTM P/E relative to CNI NTM P/E since
2012
1.4x
1.2x
1.0x
0.8x
Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
CP/CNI Relative P/E
Mean
+/- 1. std. dev
Figure 10: CP's relative premium (discount) to CNI on a
NTM P/E basis
10%
20%
30%
(20%)
(10%)
EFTA01415834
0%
'12
'13
'14
'15
'16
CP NTM P/E Premium (Discount) to CNI
'17
DCF Framework supports our view on valuation
All told we expect rail volume growth to track fairly closely with long-term
industrial production and the overall economy. As such, we believe Canadian
railroads should generate cumulative long-term top-line growth in the range
of
3.5-4% (-2% volume and pricing). With CP in a better position to win market
share
over the next several years, in our view, we assume top-line growth at the
top end
of that range (4%) with CNI trending at the lower-end (3.5%) before
returning to
our long-term assumption of 3.75% growth in 2025+.
As shown on the following page, our DCF framework for CP translates to an
implied P/E multiple of roughly 17.5x our 2019 EPS estimate.
Page 6
Deutsche Bank Securities Inc.
EFTA01415835
31 October 2017
Railroads
Canadian Rails
Figure 11: Our DCF framework for CP translates to an implied P/E multiple of
17.5x
CP - DCF Framework
Gross Revenue
YoY Change (%)
EBIT
% margin
Implied Off BS Interest
EBIT + Interest adjustment
% margin
Cash tax rate (%)
Unlevered Free Cash Flow
NOPAT
% of revenue
D&A
% of revenue
Net Capex
% of revenue
Working capital
Unlevered FCF
Time factor
Discount factor
PV of cash flows
Price Target Derivation
NPV
Net Debt (3Q '17)
PV of Operating Leases
Implied Equity Value
4Q '18e Sharecount
USD/CAD
Implied Share Price
WACC calculation
Historical RFR
Equity Risk Premium (ERP)
Beta
Cost of equity
WACD
Tax rate
Cost of debt
% equity
% debt
WACC
44,356
7,991
288
36,077
138
EFTA01415836
$1.25
2.35%
7.00%
1.01
9.4%
5.5%
26.5%
4.0%
72%
28%
7.9%
2016
6,232
(7.2%)
2,578
2,600
2017E
6,543
2018E
6,831
2,960
24
2019E
7,265
3,226
25
2020E
7,556
3,400
2021E
7,858
3,536
27
2022E
8,172
3,678
29
3,706
2023E
8,499
3,825
30
2024E
8,839
3,978
31
2025E
9,193
4,137
32
Terminal
EFTA01415837
Value
9,537
5.0% 4.4% 6.4% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 3.75%
2,747
23
26
2,770
2,984
3,251
3,426
3,564
3,854
4,008
4,169
4,292
41.4% 42.0% 43.3% 44.4% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0%
22
33
4,325
41.7% 42.3% 43.7% 44.8% 45.3% 45.3% 45.3% 45.3% 45.3% 45.3% 45.3%
23.3% 15.0% 15.0% 15.0%
1,995
2,355
660
2,536
683
2,764
719
2,856
758
2,912
789
2,967
822
3,023
856
3,078
891
3,133
928
3,179
32.0% 36.0% 37.1% 38.0% 37.8% 37.1% 36.3% 35.6% 34.8% 34.1% 33.3%
640
963
10.3% 10.1% 10.0% 10.0% 10.0% 10.0% 10.1% 10.1% 10.1% 10.1% 10.1%
(1,066)
(17.1%)
(55)
(1,235)
(18.9%)
11
EFTA01415838
0.0
100.0%
(1,275)
(18.7%)
(10)
0.0
(1,325)
(18.7%)
7
1.0
(1,417)
(18.8%)
0
1.0
(1,478)
(18.8%)
0
1.0
(1,541)
(18.9%)
0
1.0
(1,607)
(18.9%)
0
1.0
(1,675)
(19.0%)
0
1.0
(1,747)
(19.0%)
0
1,514.0 1,790.1 1,934.1 2,165.2 2,196.3 2,223.0 2,248.3 2,272.1
2,314.4
0.0
1.0
Other Assumptions
Revenue growth 2020-2025
Terminal revenue growth
Terminal EBIT Margin
Terminal Tax Rate
Terminal D&A (% of rev.)
Terminal Capex (% of rev.)
$209 <-- Translates to —17.5x our 2019 EPS estimate
4.0%
3.75%
45.0% <--Reached by 2020
26.5%
10.1%
(19.0%)
2,294.2
EFTA01415839
0
2,330.1
1.0
100.0% 92.7% 85.8% 79.5% 73.7% 68.3% 63.3% 58.6% 58.6%
2,006.1 1,885.5 1,768.2 1,656.9 1,551.4 1,451.4 1,356.6 32,679.6
(1,812)
(19.0%)
16.6% 18.3% 19.9% 21.6% 23.2% 24.9% 26.5%
While our DCF framework for CNI translates to an implied P/E multiple of
15.5x
our 2019 EPS estimate.
Deutsche Bank Securities Inc.
Page 7
EFTA01415840
31 October 2017
Railroads
Canadian Rails
Figure 12: Our DCF framework for CNI translates to an implied P/E multiple
of 15.5x
CNI - DCF Framework
2016
Gross Revenue
YoY Change (%)
EBIT
% margin
Implied Off BS Interest
EBIT + Interest adjustment
% margin
Cash tax rate (%)
Unlevered Free Cash Flow
NOPAT
% of revenue
D&A
% of revenue
Net Capex
% of revenue
Working capital
Unlevered FCF
Time factor
Discount factor
PV of cash flows
Price Target Derivation
NPV
Net Debt (3Q '17)
PV of Operating Leases
Implied Equity Value
4Q '18e Sharecount
USD/CAD
Implied Share Price
WACC calculation
Historical RFR
Equity Risk Premium (ERP)
Beta
Cost of equity
WACD
Tax rate
Cost of debt
% equity
% debt
WACC
77,786
10,305
516
66,965
EFTA01415841
730
$1.25
2.35%
7.00%
0.92
8.8%
5.4%
26.5%
4.0%
83%
17%
8.0%
5,312
5,350
2017E
2018E
5,863
2019E
12,037 13,067 13,418 14,171
(4.6%)
41
42
6,274
2020E
6,498
2021E
6,727
6,775
2022E
6,968
2023E
7,177
2024E
7,393
2025E
14,596 15,034 15,485 15,950 16,428 16,921
7,614
45
46
47
53
Terminal
Value
17,555
8.6% 2.7% 5.6% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
5,682
49
50
52
5,723
5,905
3.75%
EFTA01415842
6,319
6,544
7,017
7,228
7,445
7,668
7,900
44.1% 43.5% 43.7% 44.3% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0%
38
44.4% 43.8% 44.0% 44.6% 44.8% 45.1% 45.3% 45.3% 45.3% 45.3% 45.3%
13.4% 15.0% 15.0% 15.0%
4,633
4,865
1,293
5,020
1,355
5,371
1,431
5,455
1,478
5,536
1,525
5,619
1,573
5,669
1,622
10.2% 9 9% 10.1% 10.1% 10.1% 10.1% 10.2% 10.2%
(2,695)
(22.4%)
(35)
(2,700)
(20.7%)
(24)
0.0
100.0%
(2,684)
(20.0%)
(8)
0.0
(2,834)
(20.0%)
(18)
1.0
(2,919)
(20.0%)
0
1.0
(3,007)
(20.0%)
0
1.0
EFTA01415843
(3,097)
(20.0%)
0
1.0
5,716
1,673
5,762
1,726
55
7,955
16.6% 18.3% 19.9% 21.6% 23.2% 24.9% 26.5%
5,847
38.5% 37.2% 37.4% 37.9% 37.4% 36.8% 36.3% 35.5% 34.8% 34.1% 33.3%
1,225
(3,190)
(20.0%)
0
1.0
10.2% 10.2% 10.2%
(3,286)
(20.0%)
0
1.0
(3,384)
(20.0%)
0
1.0
1,791
(3,511)
(20.0%)
0
3,127.9 3,433.6 3,683.1 3,950.7 4,013.7 4,054.1 4,094.6 4,101.0 4,104.0
4,103.6 4,126.8
0.0
1.0
100.0% 92.6% 85.7% 79.4% 73.5% 68.1% 63.0% 58.4% 58.4%
3,658.1 3,441.2 3,218.5 3,009.8 2,791.3 2,586.5 2,394.7 56,686.1
Other Assumptions
Revenue growth 2020-2025
Terminal growth rate
Terminal D&A (% of rev.)
Terminal Capex (% of rev.)
$73 <-- Translates to 15.5x our 2019 EPS estimate
3.00%
3.75%
Terminal EBIT Margin 45.0% <--Reached by 2022
Terminal Tax Rate
26.5%
10.2%
(20.0%)
Page 8
EFTA01415844
Deutsche Bank Securities Inc.
EFTA01415845
31 October 2017
Railroads
Canadian Rails
Deutsche Bank Securities Inc.
Page 9
Figure 13: DB North American Class I Rail Comparative Valuation Table
Current
Market
Price Price
Company (Ticker)
CSX Corp. (CSX)
Norfolk Southern (NSC)
Union Pacific (UNP)
Canadian National (CNI)
Canadian Pacific (CP)
Class I Average
Buy
51.60
60
Hold 132.80
Hold 116.37
Sell 81.21
174.74
Buy
135
129
73
209
Valuation
Rating 30-Oct Target Methodology
Blended Avg.
17.5x 2018 EPS
17.0x 2018 EPS
15.5x 2018 EPS
46,596
NTM
Cap Dividend
($mm) Yield
1.8%
EPS
2016 2017E 2018E NTM
EPS Growth
2016 2017E 2018E
YoY
YoY
YoY
Price/Earnings
5-Yr.
2016 2017E 2018E NTM Avg.
EV/EBITDA
5-Yr.
EFTA01415846
2017E 2018E NTM Avg.
2.21 2.80 2.93 2.91 22.5% 26.6% 4.5% 23.3x 18.4x 17.6x 17.7x 14.3x 9.9x 9.4x
10.1x 8.1x
17.5x 2019 EPS 24,362
Note: we are translating Canadian rail numbers to USD at an exchange rate of
USD/CAD of 1.25
37,669 2.0%
14.1x 10.0x
88,818 2.5%
15.6x 9.6x
59,924 1.9%
6.45 6.90 7.75 7.61 14.8% 7.0% 12.2% 20.6x 19.2x 17.1x 17.5x
9.4x 10.1x 8.3x
5.81 6.69 7.60 7.45 14.6% 15.2% 13.5% 20.0x 17.4x 15.3x 15.6x
9.0x 9.8x 8.8x
3.92 4.26 4.70 4.63 13.1% 8.9% 10.3% 20.7x 19.0x 17.3x 17.5x
15.6x 12.5x 11.7x 11.8x 10.9x
1.2%
1.9%
8.84 10.48 11.93 11.69 14.0% 18 5% 13.8% 19.8x 16.7x 14.6x 15.0x 16.5x 11.4x
10.5x 10.6x 11.1x
15.8% 15.3% 10.9% 20.9x 18.1x 16.4x 16.7x 15.2x 10.7x 10.0x 10.5x 9.5x
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31 October 2017
Railroads
Canadian Rails
North American Railroads
The North American rail industry is made up of seven Class I rail operators,
which
are defined as having annual revenues of at least $250M or more in 1991
dollars,
or about $475M in current terms, who operate roughly 140,000 of track miles
across the continent. In addition, there are over 20 regional railroads and
500
local railroads. Total rail volumes in North America last year totaled
roughly 35
million carloads (including intermodal) with 26.1M originating in the U.S.
(76%),
6.8M in Canada (20%), and 1.3M in Mexico (4%). The largest contributor to
North
American rail volumes comes from Intermodal (50%), followed by coal (13%) and
agricultural products (9%).
Figure 14: North American rail traffic originations by
country
76%
4%
20%
U.S. Carloads
Canada Carloads
Mexico Carloads
Figure 15: North American rail traffic by type (exintermodal)
Other
4%
Nonmetallic
minerals
13%
Autos & parts
7%
Metallic ores & metals
8%
Forest products
4%
Coal
31%
Ag & Food
Products
16%
Chems &
Petroleum
17%
The carload breakdown, however, doesn't tell us the full story. While
Intermodal
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volumes make up roughly half of North American rail carloads, it makes up
just
one fifth of revenues for the rails.
Figure 16: North American revenue contribution by type
Autos
9%
Industrial
Products
19%
Intermodal
20%
Coal
11%
Other
4%
Ag Products
18%
Chemicals
19%
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Deutsche Bank Securities Inc.
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31 October 2017
Railroads
Canadian Rails
Before discussing the revenue model and cost structure dynamics, as well as
each
commodity group in more detail, we provide a description for each commodity
and offer a brief overview of the industry structure:
■
Coal (31% of carloads) — Shipments of coal to power plants and
industrial customers. Includes anthracite, bituminous, and lignite coal;
■
Chemicals (17% of carloads) — All chemicals and related products such
as sulfuric acid, ethanol and fertilizer. Also includes petroleum and
refined oil products, such as crude, gasoline, diesel, asphalt, LPG etc.
■
Agricultural products (16% of carloads) - All food and feed-related
products: Grain (wheat, corn, oats, etc.), flour, rice soybean meal, etc.
■
Nonmetallic minerals (13% of carloads) - Crushed stone, sand, gravel,
clay and glass products used in construction; Salt used for ice control;
■
Metallic ores and metals (8% of carloads) - Manganese ore, iron ore,
copper ore, alumina and nickel ore; Finished steel products and scrap;
■
■
Autos/Parts (7% of carloads) - Finished automobiles and auto parts;
Forest products (4% of carloads) - All lumber and wood products
(except furniture), pulp mills, paper, paperboard, containers or boxes,
etc.
■
Other (4% of carloads) — all waste and everything not included above
Railroad Industry Structure
The North American rail industry is split into three classes as defined by
the
Surface Transportation Board (STB):
■
Class I: Defined as having annual operating revenues of $250M or more
in 1991 dollars, which adjusted for inflation, is around $475M today.
Class I rails account for just over two-thirds of North American track
mileage and consists of seven companies.
1. Burlington Northern Sante Fe (BNSF): Based in Fort Worth, TX, has
a network of 32,500 route miles in 28 states and three Canadian
provinces. Acquired by Warren Buffet's Berkshire Hathaway in 2010;
2. Union Pacific (UNP): Based in Omaha, NE, UNP links 23 states in the
western two-thirds of the U.S. (west of Chicago and New Orleans);
3. CSX Corp (CSX): Based in Jacksonville, FL, about 21,000 route
miles serving most of the East Coast including D.C. as well as the
Canadian provinces of Ontario and Quebec;
4. Norfolk Southern (NSC): Based in Norfolk, Virginia, operates 20,000
route miles in 22 eastern states and the District of Columbia;
5. Kansas City Southern (KSU): Based in Kansas City, Missouri,
EFTA01415850
-6,200 route miles operating in ten central U.S. states with the
shortest north/south rail route between Kansas City and ports along
the Gulf. Also operates in central and northeastern Mexico.
6. Canadian National (CNI): Based in Montreal, Canada, operates over
20,000 route miles connecting all four major ports in Canada (Prince
Rupert, Vancouver, Halifax, & Montreal) to the Gulf of Mexico. It is
the largest railway in Canada.
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31 October 2017
Railroads
Canadian Rails
7. Canadian Pacific (CP): Based in Calgary, Canada, operates
approximately 12,500 of route miles spanning six Provinces in
Canada and 13 states in the U.S. (serving cities like Minneapolis,
Milwaukee, Detroit, Chicago, and New York).
■
Class II & Class III: Defined as railroads with revenues above $40M (Class
II) or under $40M (Class III). Together they account for just under onethird
of North American track mileage, made up of over 20 regional
railroads (Class II) and over 500 local/short line railroads (Class III).
Class
II railroads connect with Class I carriers for long-haul shipping, and Class
III provide rural communities with links to larger networks. Because of
their small size short line rails are typically consolidated.
Figure 17: Regional exposure by railroad
Geographical Footprint
Region
Northwest U.S.
Southwest U.S.
Midwest U.S.
Southeast U.S.
Northeast U.S.
Canada
Mexico
UNP CSX NSC BNSF KSU CP CNI
wr
wjC
4
iiirc 4 4 4
4 4
wr g
g
wr g
g g
g g
g g
North American carload and intermodal trends
Total NA carloads have declined at a 1.6% CAGR since 2010 reflecting a 7.6%
decline in Coal volumes offset by strong growth in sectors like autos/auto
parts (+5.7%) and chemicals (+2.9%). Total traffic, which includes carloads
and
intermodal volumes, has increased at a 0.6% CAGR since 2010 — reflecting a
3 3%
growth in intermodal traffic. From a regional standpoint, Mexico has seen the
strongest growth with carloads increasing at a 4.4% CAGR amidst strength in
autos (+7.2%) and intermodal (+8.3%) while the U.S. has been the laggard.
Figure 18: Longer-term movements in NA rail traffic by
type 2010-2016 (rebalanced to 100)
100%
EFTA01415852
110%
120%
130%
140%
150%
60%
70%
80%
90%
Autos/Parts, 139%
Intermodal
Chems
Nonmetallic
Forest
Ag.
Metallic
Figure 19: Longer-term movements in NA rail traffic by
country 2010-2016 (rebalanced to 100)
100%
105%
110%
115%
120%
125%
130%
135%
Coal, 62%
2010 2011 2012 2013 2014 2015 2016
Canada
Mexico
129%
101%
110%
104%
2010 2011 2012 2013 2014 2015 2016
U.S.
Total NA
Page 12
Deutsche Bank Securities Inc.
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31 October 2017
Railroads
Canadian Rails
More recently, we have seen significant strength in Canada due to strong
Intermodal (up 11% YTD), Chemicals (up 9% YTD), and Metals traffic (up 28%
YTD). To that point, Canadian carloads are up 9% yoy through 3Q 2017— which
compares to up 3% for the U.S. railroads.
Figure 20: YoY changes in U.S. vs. Canadian rail traffic Q1 2015 - Q4 2017e
10%
15%
7%
(15%)
(10%)
(5%)
0%
5%
3%
4%
12%
9%
6%
1% 0%
U.S. Rails
Note: U.S. rails include CSX, NSC, and UNP. Canadian rails include CP and CNI
Canadian Rails
Revenue discussion
The revenue model for rail companies is fairly straight forward at a high
level -
volume (typically measured in carloads) x price (measured in average revenue
per
carload). Total company revenue per carload can depend on various factors,
such
as mix of volume (different commodities have different price points), length
of
haul, movements in core/underlying price and fuel surcharges.
In 2016, the seven Class I railroads generated roughly $78 billion in
revenue
This marked an 8% decline from 2015 amidst a 4.2% decline in rail carloads
and
4.0% decline revenue per carload (yield). The decrease in rail traffic was
largely
the result of weaker industrial production activity across North America due
to the collapse in commodity prices, looser truckload capacity (hurts
domestic
intermodal volumes), and the continued shift away from coal dependency (coal
carloads down 20% in 2016). The decline in yield, which has a few more moving
parts than volumes, was largely the result of lower fuel surcharge revenue
($2.5 billion cumulatively, or $60/carload) and mix headwinds as core-pricing
(essentially same-store pricing) was up in the low-single digits across the
industry.
EFTA01415854
We note 2016 was largely a continuation of downward trends which began in
early 2015 and things appeared to bottom in late 2016. To that point, we
expect
revenue for the industry to be up roughly 6% in 2017 reflecting easy comps,
increased industrial production activity, a rebound in coal volumes (largely
due to
a weaker USD), and increased fuel surcharge revenue. Below we depict Class I
revenue trends from 2010-2018E and a market share breakdown by rail.
Deutsche Bank Securities Inc.
Page 13
YoY Chg. In Carloads
Q1 2015
Q2 2015
Q3 2015
Q4 2015
Q1 2016
Q2 2016
Q3 2016
Q4 2016
Q1 2017
Q2 2017
Q3 2017
Q4 2017E
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31 October 2017
Railroads
Canadian Rails
Figure 21: Class I rail revenue trends 2010-2018E
100,000
40,000
50,000
60,000
70,000
80,000
90,000
13.8%
5.0% 4.6%
7.3%
6.0% 5.2%
-5.8%
-8.2%
(10%)
(5%)
0%
5%
10%
15%
Total Revenue
YoY Chg.
line w industry)
Figure 22: Class I rail market share by company & region
in 2016
NSC
13%
CSX
15%
CNI
12%
CP
6%
UNP
26%
BNSF
25%
KSU
3%
U.S./Mexico: 82%
Canada: 18%
When we look at the rails individually, carload mix plays an important
factor visa-vis
overall volume growth. For example we note CNI's total traffic increased
at a 1.7% CAGR 2010-2016, vs. +1.2% for NSC, +0.2% for CSX, -0.7% for UNP,
and -0.9% for CP. We believe the variance largely reflects mix with CNI
EFTA01415856
being the
least exposed rail to Coal (-7.6% CAGR) while nearly 60% of NSC's 2016
traffic
was represented by historically faster growing carload types such as autos/-
parts
(5.7% CAGR) and intermodal (3.3% CAGR). Additionally, we note that within mix
there is a market share component for rails that operate in similar
locations which
needs to be considered as well.
Given the impact mix, fuel and underlying pricing can have on revenue, we
focus
on underlying traffic growth to gauge organic prospects, and provide
comparative
exposure based on end market growth trends. We provide more detail on CP and
CNI in the company specific sections.
Figure 23: Exposure by key end markets for NA railroads under coverage
2016 Exposure
Autos/Parts
Intermodal
Chemicals
Ag Products
Coal
Various Other
CAGR (2010-2016) CSX NSC UNP CP
5.7%
3.3%
2.9%
(0.1%)
(7.6%)
0.1%
CNI
7.5% 6.1% 10.2% 4.9% 5.0% CSX
43.6% 53.3% 38.6% 38.7% 41.6% NSC
10.9% 6.6% 12.7% 14.5% 11.5% UNP
7.4% 8.3% 11.6% 19.5% 11.6% CP
13.0% 12.4% 13.8% 12.1% 6.4% CNI
18% 13% 13% 10% 24%
CAGR (2010-2016)
0.2%
1.2%
(0.7%)
(0.9%)
1.7%
Page 14
Deutsche Bank Securities Inc.
Revenue ($ millions)
YoY Change
EFTA01415857
31 October 2017
Railroads
Canadian Rails
Profit and pricing discussion
All Class I railroads are solidly profitable in North America, with the
companies
under our coverage universe (CP, CNI, CSX, NSC, UNP) reporting an average
ebit
margin of 36.5% in 2016. This makes sense to use given the consolidated
nature
of the Class I industry, price discipline, and capital intensity needed to
maintain
an efficient railroad. There is some variability in the performance,
however, with
the Canadian rails achieving superior profitability relative to the U.S.
rails.
Figure 24: Class I rail operating ratios (opex as a % of revenue) 2010-2019E
50%
55%
60%
65%
70%
75%
80%
85%
CNI
CSX
NSC
UNP
Hunter Harrison's Precision Railroading
model has helped CP and CNI achieve bestin-class
operating ratios.
61.0%
66.3%
60.5%
55.6%
55.7%
2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E
CP
One driver of profit variation is yield differentials (i.e. revenue per unit
or carload).
For example, if we look at CNI, which has the lowest operating ratio (OR),
34%
of its total traffic in 2016 came from its highest yielding end markets,
compared
to just 30% for CSX, which had the highest operating ratio of the Class I's
in
2016. As you can see below, the companies with a larger percentage of revenue
coming from higher yielding carloads typically see a lower operating ratio.
While
EFTA01415858
this does not entirely account for margin differentials (carloads are not
created
equal from an incremental margin standpoint and average length of haul needs
and # of touch points need to be considered, which we discuss later), higher
yields
do translate to higher fixed cost leverage.
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Page 15
EFTA01415859
31 October 2017
Railroads
Canadian Rails
Figure 25: Rails that generate higher yields (revenue/carload) typically
experience better fixed cost leverage
Canadian Rails
U.S. Rails
CNI
Forest products
Automotive
Metals and minerals
Intermodal
Coal
Blended
Operating ratio:
CP
Fertilizers & Sulphur
Forest Products
Grain
Rev/Car % of vol
4,084 8.5%
Petroleum and chemicals 3,629 11.5% Top half:
Grain and fertilizers
3,485 11.6%
2,908 5.0%
1,303
2,176
55.9%
34%
66%
UNP
Agricultural
Chemicals
Industrial Products
Automotive
1,509 15.5% Bottom Half Coal
1,316 41.6%
6.4%
100.0%
Rev/Car % of vol
4,757 2.4%
34%
Energy, chems, & plastics 3,408 9.9%
Potash
2,904 4.6%
Metals, minerals & consum2,880 7.8%
2,814 4.9%
1,990 12.1%
38.7%
Autos
Coal
EFTA01415860
Intermodal
Blended
Operating ratio:
1,343
2,400
58.6%
100.0%
Bottom Half
66%
NSC
Chemicals
Paper/clay/forest
4,154 2.6% Top half: Ag/consumer/gov't
3,426 17.1%
Automotive
Intermodal
Blended
Operating ratio:
CSX
Chemicals
Forest Products
Metals & Equipment
Ag & Food Products
Automotive
Coal
Fertilizers
Minerals
Intermodal
Blended
Note: Canadian Rev/Carload is in C$
Operating ratio:
Intermodal
Blended
Operating ratio:
Rev/Car % of vol
3,699 11.6% Top half:
3,235 12.7%
3,052 13.0%
37%
2,317 10.2% Bottom Half
2,093 13.8%
38.6%
63%
1,139
2,203
63.5%
100.0%
Rev/Car % of vol
3,464 6.6%
2,620 3.9% Top half:
EFTA01415861
2,575 8.3%
2,213 6.1%
22%
Metals and construction 1,847 9.4% Bottom Half
Coal
1,649 12.4%
53.3%
573
1,362
68.9%
100.0%
Rev/Car % of vol
3,130 10.9%
2,821 4.2% Top half:
2,718 4.0%
2,696 7.4%
2,616 7.5%
2,187 13.0%
1,543 4.7%
1,497 4.8%
43.6%
30%
614
1,716
70.4%
100.0%
78%
Bottom Half
70%
Against the aforementioned yield characteristics, we note that operating
costs
per carload averaged about $1,150 in 2016 and were about 15% higher for
U.S. rails than Canadian rails. On the revenue side, however, the Canadian
rails
actually generated an additional $25 per carload, or 1% more than the U.S.
rails. In our view, this highlights greater efficiency and longer lengths of
haul as
well as the aforementioned fixed cost leverage which translates to better
margin
performance for CP and CNI.
Page 16
Deutsche Bank Securities Inc.
EFTA01415862
31 October 2017
Railroads
Canadian Rails
Figure 26: Canadian Rails generated 1% more revenue
per carload than the U.S. rails on avg. in 2016...
1,500
1,550
1,600
1,650
1,700
1,750
1,800
1,850
1,900
1,839
1,813
Figure 27: ...and it cost them 15% less to move it
1,000
1,050
1,100
1,150
1,200
1,250
800
850
900
950
U.S. Rails
Canadian Rails
1,216
1,054
2,500
U.S. Rails
Canadian Rails
In order to better measure pricing and productivity we compare revenue and
cost
metrics on a revenue and gross ton mile basis (i.e. RTM and GTM),
respectively.
Revenue ton miles (RTMs) incorporate both the total weight and distance that
goods are transported (vs. carloads which do not include distance or weight)
while gross ton miles (GTMs) measure the movement of one ton of freight and/-
or
rail equipment as well as the distance transported. In our view, these items
better
reflect the overall workload of a railroad. Generally speaking, the rails
with lower
operating ratios (better margins), generate less revenue per RTM (likely
reflecting
longer length of haul and/or heavier mix of cargos) but incur even lower
EFTA01415863
costs per
GTM on a relative basis.
Figure 28: The Canadian rails revenue per RTM is
roughly 20% below the U.S. rails
0.00
0.01
0.02
0.03
0.04
0.05
0.06
0.052
0.043
0.036
0.045
0.052
Figure 29: But cost per GTM (measure of total workload)
is roughly 30% lower than U.S. peers
0.000
0.005
0.010
0.015
0.020
0.025
CNI
CP
UNP NSC
CSX
0.018
0.015
0.012
0.012
0.019
CNI
CP
UNP NSC CSX
As shown below, rails with longer lengths of haul (CNI, CP, and UNP) enjoy a
more
productive workforce as the linehaul portion of transportation typically
requires
less manpower than the loading/unloading aspect. In addition, this helps
improve
fuel efficiency as well.
Deutsche Bank Securities Inc.
Page 17
Revenue/RTM (cents)
Opex/GTM (cents)
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31 October 2017
Railroads
Canadian Rails
Figure 30: Employee productivity, as measured by GTMs
per employee (in M)
10
15
20
25
0
5
CNI
CP
UNP NSC
CSX
19.0
20.1
20.0
14.6
13.3
500
600
700
800
900
CNI
CP
Figure 31: Fuel efficiency, as measured by GTMs per
gallon of diesel consumed
1,000
1,100
1,200
1,061
1,035
919
880
801
UNP NSC CSX
Compensation/labor related costs are the largest component of operating
expenses for a railroad - accounting for over 35% of expenses on average. In
our
view, this highlights the importance of employee productivity as it provides
the
largest opportunity for margin improvement. When we compare different cost
contributions across our coverage universe, this is where CP and CNI see the
largest difference relative to the other rails. We believe a large driver
behind this
is the Precision Railroading model implemented by Hunter Harrison at both CP
and CNI (we go into more details in company-specific sections). However, we
EFTA01415865
note that Canadian rails benefit from pension differences which optically
reduces
comp/labor expenses by roughly 3-4% points. We note that this will change on
January 1, 2018 as these gains will flow through other income.
Figure 32: Employee productivity is the largest source of margin
differential for the industry (2016)
NSC
10%
15%
20%
25%
30%
35%
40%
45%
50%
0%
5%
Comp/Labor
Purchased
services,
materials, other
Fuel
D&A
Equipment &
Other Rents
Profit
CNI
CP
UNP
CSX
Page 18
Deutsche Bank Securities Inc.
% of revenue
GTM/Employee
17.6%
28.5%
16.2%
19.7%
8.7%
6.4%
GTM/gallon of fuel
10.2%
11.8%
3.1%
4.0%
44.1%
29.6%
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31 October 2017
Railroads
Canadian Rails
In addition to yield, mix, and cost considerations, overall network fluidity
also
impacts profitability. To this point we note that the major railroads report
performance measures weekly such as average train speed and terminal dwell.
■
Speed/Velocity: Train speed measures the linehaul movement between
terminals. The average speed is calculated by dividing train-miles by
total hours operated. In general the higher the average train speed the
better the network is being run, with high frequency and stop duration
translating to lower average speeds and in turn less efficiency (all else
equal).
■
Dwell: Terminal dwell is the average time a car resides at the specified
terminal location expressed in hours. Dwell has averaged 24.5 hours
YTD industry-wide, which is slightly above historical levels (23.9 hours
in 2014).
The underlying geographical characteristics of a rail footprint can have a
major
impact on the aforementioned profitability and service elements. Both CNI and
CP are transcontinental railroads accounting for 75% of Canada's railway
tracks,
while the United States railroad system is more fragmented, with over 610
total
freight railroads operating across roughly 140,000 miles of track. The U.S.
is also
more densely populated on the East Coast with seven of the largest
metropolitan
areas located east of the Mississippi River. This not only results in a
shorter
length of haul for both NSC and CSX, but introduces truck as an intermodal
competitor as well. Conversely, Canada has a lower population density (4
people
per square kilometer vs. 35 in the United States according the world bank)
and
major population centers that are more spread out on both the east and west
coast.
While the distance between major population hubs may improve length of haul
for
certain commodities for the Canadian rails, there are certain other
geographical
challenges imposed by the unique terrain and climate of Canada compared to
the U.S. The Canadian prairies, which stretch across much of the three of the
Western provinces (Alberta, Saskatchewan, and Manitoba), which make up a
significant portion of the transcontinental route, are relatively flat and
as such
have been converted into cropland. However, there are still pockets of
difficult
route portions, such as Field Hill and formerly Big Hill for CP, which has
EFTA01415867
now
been converted into the Spiral Tunnels. For railroads, a wider variation in
gradient
and curvature of tracks can result in higher maintenance and fuel costs. To
this
point, a study by Oliver Wyman in 2012 found that Canadian Pacific's network
has
steeper grades and more track curvature than CNI, which the consulting group
concluded would require an additional 203 main line AC locomotives than CNI,
resulting in increased depreciation, fuel, and maintenance costs (though
this did
not actually turn out to be the case).
Cash flow and balance sheet discussion
The very strong return profile allows railroad companies to generate
significant
operating cash flows. A disproportionate amount of this needed to be
allocated
to significant capex investments for network upgrades and expansion, new
locomotives to meet stricter emission standards, as well as other regulations
(particular in the U.S.). To these points we note that the Class I railroads
under our
coverage universe generated nearly $170B in operating cash flow cumulatively
over the last ten years (2006-2016), compared to $235B in ebitda over the
same
period. Free cash flow totaled $65B (62% of net income), as capex totaled
$103B
and averaged 17.2% of sales. Capex as a % of sales has averaged closer to
20% of
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revenue over the last five years, however, driving weaker net income
conversion
during this time. The vast majority of free cash flow has been used to
repurchase
stock, with average share counts down about 15% since 2010 (3% CAGR).
Figure 33: Cash Flow Metrics -
UNP cumulative) 2005-16
U.S. Rails (CSX, NSC,
10,000
12,000
14,000
16,000
2,000
4,000
6,000
8,000
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
U.S. Operating Cash Flow
U.S. Free Cash Flow
FCF as a % of NI
0%
20%
40%
60%
80%
100%
120%
Figure 34: Cash Flow Metrics - Canadian Rails (CNI & CP
cumulative) 2005-16
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Operating Cash Flow
Free Cash Flow
FCF as a % of NI
0%
10%
20%
30%
EFTA01415869
40%
50%
60%
70%
80%
90%
Partly driving the significant capex investment cycle was heavy investment
in new
locomotives to handle growing energy-related volumes (prior to the decline in
oil prices) and Tier 4 emissions requirements which came into effect in 2015.
Significant investments have also been made on positive train control systems
(PTC), which is a collision avoidance system that was mandated by the U.S.
Congress in 2008 to be fully operational on locomotives operating in the
U.S. by
the end of 2020. We estimate the total cost of PTC at just under $7B for the
Class I
railroads under our coverage universe with a little over $6B at CSX, NSC,
and UNP
and $900M at CP and CNI, though the vast majority (-90%) already outlayed. As
such, capex appears to have peaked and is poised to decline as a % of sales
for
the majority of Class I's, with the exception of CNI and CP who are shifting
their
focus to revenue growth.
Figure 35: U.S. rails are expected to see an improvement
in free cash flow conversion
10,000
12,000
14,000
16,000
18,000
20,000
2,000
4,000
6,000
8,000
0
0%
20%
40%
60%
80%
100%
120%
Figure 36: Canadian rails are investing for growth
10,000
1,000
2,000
3,000
4,000
5,000
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6,000
7,000
8,000
9,000
0
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
U.S. Operating Cash Flow
U.S. Free Cash Flow
FCF as a % of NI
Operating Cash Flow
Free Cash Flow
FCF as a % of NI
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Given aforementioned cash flow characteristics, debt levels are not
concerning
to us relative to underlying operating cash flow. We expect net leverage
levels to
come down modestly amidst strong free cash flow growth, with aforementioned
reduction in capex accruing to equity holders in the form of share buybacks
and
dividend increases.
Figure 37: Net leverage levels for U.S. Class I rails under
our coverage (net debt/operating cash flow)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
3.3
3.0
2.5
2.4
2.2
2.2
1.9
2.1
1.9
2.0
2.4
2.5 2.5
2.4 2.4
Figure 38: Net leverage levels for Canadian Class I rails
under our coverage (net debt/operating cash flow)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
4.0
3.7
3.2
2.7
2.4
EFTA01415872
2.1 2.1
2.5
2.1 2.1
2.4
2.6
2.4
2.2
2.1
Other important items
There are various other long-term trends/issues to consider when thinking
about
the North American railroad industry, namely currency (for CP and CNI),
NAFTA,
regulation, labor costs/unions, and fuel. We briefly discuss these issues
below:
Currency: We estimate that roughly 55% of revenue and 50% of expenses at CP
and CNI are denominated in USD. This has an obvious impact from a translation
perspective, and in general a weaker CAD / stronger USD is helpful for each
company's bottom lines (and vice versa). To this point, CP states that for
every lc
decline in the Canadian dollar relative to the USD results in a $26 million
increase
in revenue, $13 million increase in expenses, and $3 million increase in
interest
expense annually. Currency can also have an impact on the industry overall as
a number of goods hauled by rails are destined for export and fluctuations in
currencies can often impact the demand for these goods from overseas.
NAFTA: The North American railroad industry is very intertwined with
crossborder
trade throughout the U.S., Canada, and Mexico. As such, any changes
to NAFTA could potentially have significant implications for the industry.
KSU
is the most at risk, in our view, to a more protectionist approach to trade,
followed by CNI and CP. While it's clearly difficult to forecast the
ultimate outcome
of the Canada-Mexico-U.S. trade relationship, we believe the most immediate
risk would be for President Trump to withdraw the U.S. from NAFTA. In this
circumstance, commercial relationships would be regulated by the World Trade
Organization. Further, tariffs for imports into Mexico would revert to the
Most
Favored Nation (MFN) levels, translating to modest increases in tariffs while
trade with Canada would revert to a baseline free trade agreement which has
been in existence since the 1980's. For more details around the ongoing NAFTA
negotiations, please click here for DB Strategist Sebastian Brown's recent
note
on the subject.
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Regulation: The key governing bodies which oversee railroad operations in
North
America are the Surface Transportation Board (STB), the Canadian
Transportation
Agency and Transport Canada. The Surface Transportation Board (STB) is the
primary regulatory body in charge of overseeing all rail operations in the
U.S.,
and was borne out of the old ICC in 1996. It has jurisdiction over rail rate
reasonableness, mergers, line acquisitions, new rail-line construction, and
line
abandonment. Recently the industry has been grappling with rate caps, forced
access, and commodity re-regulation. With rate caps, the STB is representing
the shippers, particularly in coal and agriculture, in placing upper limits
on what
rails can charge for shipment. Forced access in the rail industry would mean
mandated reciprocal switching, which is when a rail would have access to
another
rail's infrastructure for access to locations it would not normally have
access
to, giving customers access to more than one rail at its location. The goal
is to
promote competition and the measure will likely cause downward pressure on
pricing as rails will be competing for customers on the same line. The
commodity
re-regulation push would establish a means for the STB to have oversight on
rates but also how commodities are moved. While the STB regularly pushes for
new regulations, we note that the rail lobby pushes back, and the likelihood
of regulations going into effect is unclear. However, we still highlight
that STB
regulation as a potential issue for rails vis-à-vis price and costs.
Canadian rail operations are subject to administration by the Canadian
Transportation Agency and Transport Canada. They also are primarily
responsible
for enforcing Railway Safety Act, one of the major frameworks for the
Canadian
railway industry which was first implemented in 1989. This act promotes
railway
safety and security and contains standards on the construction, maintenance,
and alteration of networks, public safety concerning railways, and so on.
Transport Canada enforces safety oversight and enforcement for the Canadian
rail
industry, conducting safety audits and regulating the equipment and
engineering
standards, and also overseeing the transportation of dangerous goods. The
Canadian Transportation Agency sets the government's national transportation
policy in the Canada Transportation Act. It has jurisdiction over tasks such
as
approving the construction of railway lines, licensing rail carriers, and
EFTA01415874
giving
financial and cost oversight and guidelines to certain railways.
Unions: All Class I railroads in North America have union representation.
The major unions in the U.S. are the United Transportation Union (UTU), the
Brotherhood of Locomotive Engineers & Trainmen (BLET), and the Brotherhood of
Railroad Signalmen (BRS). Railway labor relations are governed under the
Railway
Labor Act (RLA), which has been in existence since 1926 and sets guidelines
for contract negotiation, dispute settlement, and strike ending/-
repercussions.
Strikes, while technically allowed by the RLA for "major disputes", are
highly
unlikely as it can only happen after exhaustive mediation (with no time
limit as
set by the National Mediation Board), and ultimately potential involvement
by the
U.S. President before a strike can be declared (the last major strike
occurred in
1922 and ended with involvement by the National Guard). There are associated
unions that present a more real risk factor: Ports, for example, can cause
volume
disruptions as the International Longshore & Warehouse Union did when it went
on strike in late 2014.
Most of the major U.S. unions have representation in Canada as well as the
Teamster Canada Rail Conference (TCRC), UNIFOR, the Canadian Auto Workers
(CAW), and the United Steel Workers of America (USWA). The TCRC provides
representation to over 16,000 Canadian rail workers and is the major
collective
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31 October 2017
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bargaining partner for CNI and CP, while UNIFOR also provides representation
for employees of CNI. Canadian rails have a history of going on strike and
often
tense relations with management — CP workers went on strike for roughly one
day in 2015 and for nine days in 2012 before the Teamsters union and CP
agreed
to arbitration over longwithstanding issues such as pay and benefits, the
pension
plan, rest time for employees, etc The Canadian gov't stepped in with
legislation
to end the strike in 2012, and CNI narrowly avoided strikes in 2014 and 2015
after
workers complained about the same issues as CP. Many of the changes brought
about as part of Harrison's Precision Railroading plan at various railroads
have
led to tense relations between employees and mgmt.
Fuel: Railroad fuel surcharge revenue is pegged to either WTI crude or
onhighway
diesel prices, meaning that when either of these two commodities hits
a certain level, customers will be charged a different price under fuel
surcharge
revenue agreements. The mechanism is typically structured with a two month
lag, meaning the surcharge mechanism is pegged to a commodity price from two
months ago (for example, on July 1 the mechanism will be utilizing May 1
prices).
Because of the lag a rising fuel price environment will be a temporary drag
on
profitability and vice versa. We view these trends as neutral over a mid/-
long-term
basis.
Rail End Markets Overview and Outlook
While demand for U.S. and Canadian carloads generally comes from similar
sources, the revenue contribution varies given the difference in geographical
footprints. We note that U.S. rails have significantly higher exposure to
Coal (14%
of revenue in 2016) relative to the Canadian rails (6% of revenue). As one
would
expect, agricultural products represent a bigger piece of the pie for
Canadians
(21% of revenue) than it does for the U.S. rails (16% of revenue). Below we
provide
a side-by-side breakdown of revenue contribution for the U.S. rails (CSX,
NSC, &
UNP cumulatively) vs. the Canadian rails (CNI & CP cumulatively).
Figure 39: U.S. rail revenue contribution 2016 (CSX,
NSC, UNP)
Autos
10%
EFTA01415876
Intermodal
19%
Coal
14%
Industrial
Products
18%
Ag
Products
16%
Chemicals
19%
Coal
6%
Figure 40: Canadian rail revenue contribution 2016 (CNI
& CP)
Other
4%
Autos
6%
Intermodal
23%
Chemicals
18%
Industrial
Products
21%
Ag
Products
21%
Other
5%
Intermodal
Intermodal volumes represented roughly half of all North American rail
traffic in
2016. It encompasses freight movements using more than one mode of transport,
i.e. ship to truck, truck to train, train to truck, etc. with multiple moves
over
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the course of a trip. In general, cargo includes almost everything under the
sun,
from electronics to food to furniture. In both the U.S. and Canada, retail
sales is
generally the best gauge for prospective movements in intermodal volumes.
Figure 41: YoY change in U.S. Intermodal volumes and
U.S. retail sales
10%
15%
(15%)
(10%)
(5%)
0%
5%
Correlation: 83%
U.S. Intermodal Volumes
(30%)
(20%)
(10%)
0%
10%
20%
30%
U.S. Retail Sales
Figure 42: YoY change in Canadian Intermodal volumes
(RHS) and CA retail sales (LHS)
10%
(10%)
(5%)
0%
5%
Correlation: 88%
CA Intermodal Volumes
(30%)
(20%)
(10%)
0%
10%
20%
30%
CA Retail Sales
Since 2000, U.S. and Canadian Intermodal volumes have increased at a 2.4%
and 3.4% CAGR, respectively (vs. 2016) with growth averaging roughly 5% from
2011-2014 as railroad customers made significant investments in capacity and
improved service. Volumes were also positively impacted in 2013-2014 in part
by tighter trucking capacity (which drives spill-over effect to rails) and
EFTA01415878
higher
fuel costs given rail's significant fuel efficiency advantage. Intermodal
volumes
came under pressure in late-2015 due to the collapse in fuel prices, looser
truck
capacity, and a stronger USD. To that point, NA intermodal volumes declined
1.5% yoy in 2016. Year-to-date, however, intermodal volume growth has
returned
(up 5% yoy through 3Q) due to a modestly tighter truckload market and a
weaker
USD (reviving international trade).
Figure 43: Avg. weekly U.S. Intermodal volumes and
YoY changes (2000-'17 3Q)
100,000
150,000
200,000
250,000
300,000
50,000
0
Intermodal Volumes
YMY VN
(30%)
(20%)
(10%)
0%
10%
20%
30%
Figure 44: Avg. weekly CA Intermodal volumes and YoY
changes (2888-'17 3Q)
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
0
Intermodal Volumes
YMY Rf
(30%)
(20%)
(10%)
0%
10%
20%
30%
EFTA01415879
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Deutsche Bank Securities Inc.
Jan-00
Jul-01
Jan-03
Jul-04
Jan-06
Jul-07
Jan-09
Jul-10
Jan-12
Jul-13
Jan-15
Jul-16
'05
'06
'07
'08
'09
'10
'11
'12
'13
'14
'15
'16
Jan-00
Jul-01
Jan-03
Jul-04
Jan-06
Jul-07
Jan-09
Jul-10
Jan-12
Jul-13
Jan-15
Jul-16
'05
'06
'07
'08
'09
'10
'11
'12
'13
'14
'15
'16
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31 October 2017
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Domestic intermodal traffic accounts for a little over half of North American
Intermodal volumes with the balance accounted for by international. Domestic
is
largely driven by over the road conversions to intermodal from truck, with
loose
truck capacity translating to lower rates making rails less attractive.
International
covers containers coming in and going out of the country (via ports), with
currency
and global trade being the key drivers behind volumes. We note that
Intermodal
growth in Canada (+11.2% ytd) has outpaced the U.S. (+3.7% ytd) so far in
2017,
as investments at the ports of Vancouver and Prince Rupert are attracting
more
imports (see figure below). We note that Prince Rupert, for example,
completed
an expansion in August which increased throughout capacity by nearly 60% to
1.35M TEU's annually. This will likely provide a tailwind for CNI over-and -
above
any improvements in global trade (please see company specific notes for more
details). Underlying our railroad models is the assumption of —5% growth in
intermodal volumes next year and beyond, helped in part by our expectation
for tighter truck capacity in the U.S. (less of an impact for CNI given its
higher
exposure to international [63%]) and modest growth in global trade. Below we
provide a table which shows a number of important NA ports ranked by total
import TEU's in 2016 and their import growth YTD (through September).
Figure 45: Import statistics for key North American ports
2016
Rank Port
1 Los Angeles
2 Long Beach
YTD TEU's YoY Change
6.7%
2,662,372
2,137,232
3 New York-New Jersey 1,847,748
4 Georgia Ports
5 Vancouver, BC
6 Seattle-Tacoma
7 Virginia Ports
8 Houston
9 Charleston
10 Oakland
EFTA01415881
16
Prince Rupert
291,056
9.8%
1.6%
CNI
1,063,781
957,107
843,358
711,816
604,622
638,406
691,671
6.9%
1.6%
12.2%
12.0%
10.8%
8.9%
24.0%
7.1%
4.1%
2016 Market
Share
16.6%
12.6%
11.8%
6.2%
5.6%
5.2%
4.3%
3.2%
Strong growth in imports at the two
Canadian ports (Vancouver and Prince
Rupert)
is driving stronger
Class I Rail Service
BNSF, UNP
BNSF, UNP
CP, CSX, NSC
CSX, NSC
CNI, CP
BNSF, UNP
CSX, NSC
3.3% BNSF, KSU, UNP
3.3%
CSX, NSC
BNSF, UNP
relative
intermodal growth for the Canadian rails in
EFTA01415882
2017.
From here, carload dynamics start to differ more between Canadian and U.S.
rails. For example, coal represented the largest percentage of U.S. rail
carloads
in 2016 (31% ex-intermodal) while it ranked 5th out of 7 in terms of carload
exposure for Canadian rails. Below we provide a side-by-side breakdown of
carload contribution for U.S. and Canadian rails.
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Figure 46: U.S. Carload breakdown (ex-intermodal)
Other
4%
Nonmetallic minerals
13%
Autos & parts
7%
Metallic ores & metals
8%
Forest products
4%
Coal
31%
Ag & Food
Products
16%
Figure 47: Canadian carload breakdown (ex-intermodal)
Chems &
Petroleum
17%
Nonmetallic
minerals
7%
Autos &
parts
7%
Metallic
ores &
metals
17%
Other
2%
Ag & Food
Products
22%
Chems &
Petroleum
24%
Forest
products
11%
Coal
10%
Coal
Coal volumes account for roughly one third of U.S. carloads (ex-intermodal)
but
EFTA01415884
just 10% of Canadian carloads (ex-intermodal). Cumulatively in NA, coal
accounts
for a little over one quarter of all carloads (ex-intermodal) which is down
from just
under 40% in 2010. Much of this decline is due to increased supply of natural
gas, with 2016 becoming the first year that natural gas has exceeded coal in
U.S.
electricity generation on an annual basis.
Figure 48: Average weekly coal carloads have been
under pressure...
100,000
120,000
140,000
160,000
180,000
60,000
80,000
159,654
96,522
20%
40%
60%
80%
0%
Coal
Nat Gas
Other
Figure 49: ...as U.S. electric generation has become less
dependent on coal
100%
The decline, while significant, has not been linear, with volatility driven
by changes
in relative price and weather. The long-term trend is undeniable, however,
resulting from the drastic decline in natural gas prices following the
hydraulic
fracturing-fueled U.S. shale boom. To put the move in context, the price of
natural
gas was roughly seven times more expensive than coal ten years ago (October
2015 MIT study), and today those prices are in parity with coal (including
transport
costs associated with coal). We have witnessed a 65% correlation with U.S.
coal
carloads and natural gas prices over the past ten years.
Page 26
Deutsche Bank Securities Inc.
Jan-00
Jun-01
Nov-02
Apr-04
EFTA01415885
Sep-05
Feb-07
Jul-08
Dec-09
May-11
Oct-12
Mar-14
Aug-15
Jan-17
% of electric generation
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
49%
22%
30%
30%
30%
34%
28%
36%
42%
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31 October 2017
Railroads
Canadian Rails
Figure 50: NA Coal carloads have declined as natural
gas prices have moved closer to parity with coal
$10
$15
$0
$5
'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Nat Gas Henry Hub Spot
EIA,
Price
AAR
($/Mbtu)
Cost of coal delivered to electric plants ($/Mbtu)
Avg. Weekly Coal Carloads
160,000
Figure 51: NA coal carloads vs. spread between nat gas
and coal
Spread btwn nat gas and coal
Avg. Weekly Coal Carloads
$10
$15
110,000
60,000
-$5
$0
$5
'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
60,000
80,000
100,000
120,000
140,000
160,000
Given the aforementioned correlation, the outlook for natural gas prices is
critical
to gauge short- to medium-term prospects for coal shipments. To this point we
note that Deutsche Bank's Commodities team forecasts natural gas prices to
hover around $3.00 in 2018 and $3.10 in 2019. While volumes have somewhat
recovered from the lows in early 2016, we expect pressure on coal volumes to
persist long-term largely beginning again in 2019/2020 - albeit to a lesser
extent
than what we witnessed in 2014-15. Other factors that could drive
improvements
are a much weaker dollar and a much colder winter, which incentivizes exports
and lowers inventories, respectively. We note that CNI is the least exposed
of any
major Class I rail with just 4% of revenue coming from coal in 2016.
Figure 52: DB U.S. Natural Gas supply/demand model (base case)
2011A
Residential & Commercial
EFTA01415887
Power Generation
Industrial
Pipeline Exports
LNG Exports
Other
Total Demand (bcf/d)
Marcellus & Utica
Haynesville
Associated
Barnett
Faytteville
Other L48
Offshore Gulf
Pipeline Imports
Total L48 Supply
Total Supply (bcf/d)
21.7
20.7
19.2
1.4
5.6
68.5
4.8
9.8
12.2
4.9
2.5
25.5
5.0
5.9
59.7
70.6
Year End Working Gas Storage (bcf)
19.3
24.9
19.8
1.7
5.9
71.5
7.7
9.8
13.8
4.8
2.8
25.0
4.1
5.4
63.8
73.4
EFTA01415888
22.5
22.4
20.4
1.8
6.4
73.5
11.2
7.7
15.4
4.5
2.8
23.5
3.6
5.1
65.1
73.8
23.6
22.3
20.9
2.0
6.5
75.3
14.7
6.7
21.6
26.5
20.6
2.9
6.8
78.3
20.6
27.3
21.2
3.7
0.5
6.4
79.7
6.2
17.8
4.2
2.7
23.0
3.4
5.1
69.1
77.7
20.0
3.8
EFTA01415889
2.7
22.0
3.5
5.3
74.3
83.1
22.0
6.0
19.5
28.2
21.9
5.1
1.7
6.4
82.9
Natural Gas Supply Summary (bcf/d)
19.5
19.8
3.5
2.4
19.4
3.3
5.8
73.0
82.2
23.5
6.4
20.0
3.2
2.1
18.4
3.3
6.3
73.6
83.2
21.3
30.2
22.8
7.0
3.0
6.5
90.8
27.5
7.1
23.1
3.0
2.1
18.4
3.3
6.8
81.2
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91.3
2012A 2013A 2014A 2015A 2016E 2017E
Natural Gas Demand Summary (bcf/d)
2018E 2019E 2020E
21.3
30.5
23.2
7.9
5.4
6.5
94.8
31.1
7.7
24.7
2.8
2.0
18.1
3.2
6.9
86.5
96.6
21.3
30.8
23.5
9.1
7.7
6.5
98.8
31.9
8.5
25.2
2.7
1.8
17.9
3.0
6.9
88.1
98.0
3,413 2,890 3,141 3,677 3,306 3,029 3,185 3,843 3,555
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Agricultural Products
Agricultural products make up 18% of total carload traffic (ex-intermodal)
in North
America - 22% in Canada and 16% in the U.S. Ag carloads are comprised
primarily
of grain but also include non-grain products such as soybeans and food
products.
Demand for North American ag products comes from international markets as
well as domestic and is largely driven by demand for food, which points to
population growth, while supply is driven by a combination of crop yields
and a
farmer's willingness to sell rather than silo crops, which is dictated by
commodity
prices. Exports are affected by the size and quality of the harvest as well
as
currency, though Canadian exports are typically more stable given a higher
quality
grain product. To that point, U S. ag volumes have come under pressure lately
(-12% yoy in 3Q) while Canadian ag demand has been somewhat more resilient
(carloads -6% in 3Q) due to the record crop in South America and difficult
comps.
Figure 53: Avg. weekly U.S. Ag carloads & YoY changes
(2012-'17 3Q)
25,000
30,000
35,000
40,000
45,000
Avg. Weekly Ag Carloads
YoY Chg.
(20%)
(15%)
(10%)
(5%)
0%
5%
10%
15%
20%
Figure 54: Avg. weekly Canadian. Ag carloads & YoY
changes (2012-'17 3Q)
10,000
15,000
20,000
25,000
5,000
EFTA01415892
0
Avg. Weekly Ag Carloads
(30%)
(20%)
(10%)
0%
10%
20%
30%
40%
50%
Overall ag volumes are expected to be down in the next couple of quarters as
the
rails lap difficult comps and an extremely strong 2016/17 crop season. We
believe
U.S. ag volumes will likely see steeper declines due to increased
competition from
South America. All in all we expect ag volumes to bottom in 20/30 of 2018.
As you
can see below, carload trends are closely related to grain production which
can
vary significantly from year to year. In 2018, we expect tailwinds from
increased
potash demand to offset modestly lower grain volumes.
Page 28
Deutsche Bank Securities Inc.
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Jul-17
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
Jun-14
Dec-14
Jun-15
Dec-15
Jun-16
Dec-16
Jun-17
EFTA01415893
31 October 2017
Railroads
Canadian Rails
Figure 55: Canadian grain production 2012/13 -
2017/18E
45
50
55
60
65
70
75
80
5-Yr Avg.
77
63
58
65
72
66
Figure 56: CP & CNI annual ag carloads 2013-2018E
1,000
1,050
1,100
1,150
950
2013 2014 2015 2016 2017e 2018e
Economically sensitive carloads
We consider the remaining carloads, which make up 56% of all rail carloads
(exintermodal)
and consist of Chemicals (18%), Nonmetallic minerals (12%), Metals
(11%), Autos and auto parts (8%) and Forest products (5%), to be more
closely tied
to the underlying economy than the aforementioned commodities. These carloads
can be classified as economically sensitive and we have found a strong
correlation
with industrial production. Since 2005, U.S. econ-sensitive carloads have
shown
an 82% correlation with U.S. Industrial Production while Canadian econ-
sensitive
carloads have exhibited a 71% correlation with Canadian Industrial
Production.
Figure 57: YoY change in U.S. econ-sensitive carloads
(RHS) vs. Industrial Production (LHS)
10%
15%
(20%)
(15%)
(10%)
EFTA01415894
(5%)
0%
5%
Correlation: 88%
U.S. Econ-Sensitive Carloads
U.S. IP
(40%)
(30%)
(20%)
(10%)
0%
10%
20%
30%
Figure 58: YoY change in Canadian econ-sensitive
carloads (RHS) vs. Industrial Production (LHS)
10%
15%
(20%)
(15%)
(10%)
(5%)
0%
5%
Correlation: 71%
CA Econ-Sensitive Carloads
CA IP
(60%)
(40%)
(20%)
0%
20%
40%
60%
Before we provide more details on the remaining carload classifications, we
believe it is important to note the relationships between the U.S. and
Canadian
economy. The United States is Canada's largest trading partner, with approx.
75% of Canada's total exports going to the United States in 2016, therefore
making overall demand in the United States an important driver to Canada's
economy. Furthermore according to Deutsche Bank's Economics team, exports
are a greater share of Canada's total GDP (23%) compared to the United States
(13%). Total merchandise trade with the U.S. has increased 3x from 1990 to
2016
largely due to the signing and implementation of NAFTA. Therefore, we believe
Deutsche Bank Securities Inc.
Page 29
'05
'06
EFTA01415895
'07
'08
'09
'10
'11
'12
'13
'14
'15
'16
'05
'06
'07
'08
'09
'10
'11
'12
'13
'14
'15
'16
'17
EFTA01415896
31 October 2017
Railroads
Canadian Rails
overall U.S. GDP is also a good barometer for North American econ-sensitive
carloads as a whole
Figure 59: The U.S. and Canadian economies are closely linked
Canada: Real GDP
7.5
10
2.5
5
-2.5
0
-5
82
87
92
97
02
Analytics
07
12
17
Correlation=0.82
% Y/Y
US: Real GDP
% Y/Y
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
Figure 60: Canada is the United
States' 2nd largest trade partner
YTD Total Trade
(goods, $Bn)
% of Total
Trade
China
Canada
Mexico
Japan
Germany
South Korea
U.K.
Others
Total
342.8
EFTA01415897
335.2
318.3
116.7
96.7
70.2
62.1
865.8
2,207.8
15.5%
15.2%
14.4%
5.3%
4.4%
3.2%
2.8%
39.2%
100%
■
Chemicals - Chemicals account for 19% of total NA carload traffic
(ex-intermodal) - 25% in Canada and 16% in the U.S. Over 70% of
chemical carloads are accounted for by core chemical products (+2%
YTD) with the balance coming from petroleum & refined products (-5%
YTD). Core chemicals consist of a wide array of products, including
ethanol, other industrial chemicals, plastics and resins, with most
used in manufacturing. We note that almost all manufactured goods
require chemicals during production - for example, DB's Chemicals team
estimates that —$3,500 of chemicals go into the production of each
automobile in the U.S. As such, core chemical shipments tend to rise
and fall with overall industrial activity in North America (78% correlation
with U.S. industrial production), with oil and oil products fluctuating with
commodity price, production, and pipeline capacity.
Page 30
Deutsche Bank Securities Inc.
EFTA01415898
31 October 2017
Railroads
Canadian Rails
Figure 61: YoY changes in NA Chemical carloads (RHS) vs. U.S. Industrial
Production (LHS)
10%
15%
20%
(20%)
(15%)
(10%)
(5%)
0%
5%
Correlation: 78%
NA Chemical Carloads
U.S. Industrial Production
(25%)
(20%)
(15%)
(10%)
(5%)
0%
5%
10%
15%
20%
25%
■
As shown below, crude by rail export volumes from Canada have
rebounded nicely in 2017 (+56.5% YTD) supporting growth in chemicals
carloads after a challenging 2015/16. We see opportunities for the
Canadian rails, particularly CP, to benefit from increased demand for
crude by rail in 2018/19 as the supply of Canadian crude exceeds pipeline
capacity. To this point, the Canadian Association of Petroleum Producers
estimates that the supply of oil from Western Canada will increase at a
3.6% CAGR from 2017-2020 to over 4.5 million barrels per day, well in
excess of current pipeline capacity of 4M bbl/day.
Figure 62: Canadian crude by rail export volumes and
yoy changes (2014 - present)
100
150
200
50
Crude by Rail Volumes
Yf Y VW
(100%)
(50%)
EFTA01415899
0%
50%
100%
150%
200%
Figure 63: Western Canadian oil supply likely to exceed
pipeline takeaway capacity until 2020
30
35
40
45
50
Western Canadian Oil Supply
Current pipeline capacity
2014 2015 2016 2017e 2018e 2019e 2020e
■
Motor Vehicles and parts - Autos and auto parts account for roughly 8%
of bot U.S. and Canadian carloads (ex-intermodal) and generally track
light vehicle production. Carloads have seen strong growth since the
recession as light vehicle sales have increased from 10M units in 2009 to
17.7M in 2016. However, Deutsche Bank's autos team believes the auto
Deutsche Bank Securities Inc.
Page 31
bbl/day (thousands)
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-16
May-16
Sep-16
Jan-17
May-17
YoY Chg
bbl/day (millions)
'05
'06
'07
'08
'09
'10
'11
'12
'13
'14
'15
'16
'17
EFTA01415900
EFTA01415901
31 October 2017
Railroads
Canadian Rails
market has likely peaked, with North American light vehicle production
expected to be down 2% in 2017 after 7 years of expansion, which is
pressuring auto volumes (-9% YTD).
Figure 64: Motor vehicles and parts carloads trends
(U.S. + Can) since 2012
10,000
15,000
20,000
25,000
30,000
Avg. Weekly Carloads
YMY MI
(20%)
(10%)
0%
10%
20%
30%
40%
Figure 65: North American light vehicle production is
expected to be down 2.1% in 2017
10%
20%
30%
(30%)
(20%)
(10%)
0%
■
Non-metallic minerals & products - This category accounts for roughly
12% of total carloads traffic (ex-intermodal) in North America - 8% in
Canada and 14% in the U.S. It is comprised of crushed stone & gravel,
nonmetallic minerals, and stone, clay, and glass. Demand for these
products is generally driven by construction and industrial activity. The
oil and gas industry is a large customer for nonmetallic minerals as
drilling activity drives demand for aggregates/gravel and frac sand which
has been extremely volatile over the past several years.
Figure 66: Non-metallic minerals & products carloads
trends (US + Can) since 2012
20,000
25,000
30,000
35,000
40,000
45,000
50,000
EFTA01415902
Avg. Weekly Carloads
YMY
(15%)
(10%)
(5%)
0%
5%
10%
15%
20%
25%
Figure 67: U.S. frac sand carloads closely track the rig
count
100%
150%
50%
(100%)
(50%)
0%
96% Correlation
U.S. Rig Count
Frac Sand Carloads (U.S. Class I rails)
■
DB's Oil Services and Equipment team forecasts moderate rig count
growth in 2018. Overall rig counts in North America are expected to grow
5.9% yoy in 2018. On a per country basis, growth is estimated at +5%
Page 32
Deutsche Bank Securities Inc.
Jan-12
Jul-12
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Jul-17
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
EFTA01415903
Jul-16
Jan-17
Jul-17
YoY Change
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Q1 2016
Q3 2016
Q1 2017
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017E
2018E
(2.1%)
(0.1%)
EFTA01415904
31 October 2017
Railroads
Canadian Rails
yoy in Canada and +6.3% in the U.S. We note that any moderation in
rig count growth would pose a risk to industrial activity in the U.S. given
their 88% correlation and likely puts pressure on energy related carload
demand. We note that these rig count forecasts are largely dependent
on oil prices staying relatively stable and lower prices would present
additional risks to the current environment.
Figure 68: DB's Oil Services team forecasts 6% growth in rig count in 2018
(e)
(e)
Rig count forecast
United States
Oil-directed rigs
Gas-directed rigs
Total U.S. land rigs
Sequential chg
Gulf of Mexico
Canada
Sequential chg
North America
1016 2Q16 3Q16 4016 1Q17 2017 3Q17 4Q17
427
108
535
(26%)
26
166
(5%)
727
315
82
397
(26%)
23
48
(71%)
468
374
85
459
16%
18
121
152%
598
449
117
565
23%
EFTA01415905
22
181
50%
573
148
721
27%
20
295
699
174
873
21%
21
117
63% (60%)
746
182
928
206
76%
735
170
905
6% (3%)
21
21
300
769 1,036 1,011 1,155 1,225
2016
391
98
489
(48%)
22
129
46% (34%)
(e)
2017
688
168
856
75%
21
230
78%
(e)
2018
744
167
EFTA01415906
911
6%
21
241
5%
641 1,107 1,173
■
Metallic Ores & Metals - Metallic ores & metals account for about
11% of total carload traffic (ex-intermodal) in North America - 17%
in Canada and 9% in the U.S. The business is made up of metallic
ores, coke, metals/metal products, and iron/steel and is generally driven
by overall industrial activity with specific exposure to the oil and gas,
construction and auto industries. The business has fluctuated with the
swings in oil and gas production in recent years though has rebounded
lately with volumes up roughly 12% ytd after declining 14% and 5% in
2015 and 2016, respectively. Additionally, the USD can impact global
metals demand and recent weakness is likely supporting growth for the
business due to increased demand for exports.
Figure 69: Metallic ores & Metals carload trends (U.S. + Can) since 2012
20,000
25,000
30,000
35,000
40,000
45,000
50,000
(40%)
(30%)
(20%)
(10%)
0%
10%
20%
30%
Avg. Weekly Carloads
VW( VW
■
Forest products - Forest products account for roughly 5% of total
carload traffic (ex-intermodal) in North America - 11% in Canada and
4% in the U.S. The business is largely comprised of lumber, paper,
Deutsche Bank Securities Inc.
Page 33
Avg. Weekly Carloads
Jan-12
May-12
Sep-12
Jan-13
May-13
Sep-13
Jan-14
EFTA01415907
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-16
May-16
Sep-16
Jan-17
May-17
Sep-17
YoY Change
EFTA01415908
31 October 2017
Railroads
Canadian Rails
wood pulp, and paper. Demand for forest products is largely driven
by construction and building activity, with U.S. housing starts (71%
correlation with rail carloads since 2000) and industrial production
serving as solid indicators for prospective forest products demand. We
note that Canada is the largest exporter of softwood lumber in the world
and the U.S. is its biggest market. As such, the recent import tariff
imposed by the U.S. on imports of Canadian lumber has resulted in a
modest deviation in volume trends with U.S. originated forest product
carloads down 1% ytd while Canadian forest product carloads are down
3% ytd.
Figure 70: Forest products carload trends (U.S. + Can)
since 2012
15,000
16,000
17,000
18,000
19,000
20,000
Avg. Weekly Carloads
Yiig at
(10%)
(5%)
0%
5%
10%
Figure 71: DB expects single-family U.S. housing starts
to grow 9% in 2018
10%
20%
30%
40%
(20%)
(10%)
0%
Railroad Valuation
Railroad shares are up 27% on average year-to-date (CP, CNI, CSX, NSC, UNP),
vs.
+15% for the S&P 500. CSX has been the clear winner following the appointment
of Hunter Harrison as CEO while performance has been relatively similar
across
the remainder of the group. This year's performance follows a strong 2016
(+29%
on avg.) amidst an improvement in the industrial economy, easy comps, and a
recovery in energy prices.
Figure 72: Total Return (including dividends) for railroad shares since 2014
Total Return 2016
EFTA01415909
20%
40%
60%
0%
CP CNI CSX NSC UNP S&P
500
Total Return YTD
48%
23% 22%
25%
15% 15%
20%
40%
60%
0%
CP CNI CSX NSC UNP S&P
500
41%
31%
23%
13%
10%
35%
10%
20%
1%
(20%)
(10%)
0%
-5%
-14%
CP CNI CSX NSC UNP S&P
500
-4%
-2%
Total Return 2014-15
11%
Page 34
Deutsche Bank Securities Inc.
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
EFTA01415910
Jul-17
Jan-15
Apr-15
Jul-15
Oct-15
Jan-16
Apr-16
Jul-16
Oct-16
Jan-17
Apr-17
Jul-17
Oct-17
EFTA01415911
31 October 2017
Railroads
Canadian Rails
Shares of rail companies have consistently outperformed the market since
2000, generating an average annualized return of 16.5% (including dividend
reinvestment) compared to 5.1% for the S&P 500. CNI has been the strongest
performer with a 19.8% CAGR while CSX has been the group's laggard (15.4%
CAGR) due largely to a lower dividend yield. During this time, shares of
railroad
companies have experienced three major up-cycles with two periods of extended
weakness. Outperformance and/or underperformance within the group have been
driven by a number of different factors throughout different cycles, though
recently investors have been more eager to reward companies for potential
margin expansion. The first major major up-cycle for the industry lasted from
2000 until 2008. As seen below, CNI was the clear winner during this time as
the company expanded its network through a number of acquisitions, generated
best-in-class volume growth, and removed costs through the implementation of
Hunter Harrison's Precision Railroading model.
Figure 73: The rails solidly outperformed the S&P 500 from 2000-2008 with
CNI leading the way
100
200
300
400
500
600
700
0
2000
2001
2002
2003
2004
2005
2006
2007
CNI
CP
UNP
NSC
CSX
S&P 500
After peaking in May 2008, railroad shares fell 60% on average,
underperforming
the broader market (the S&P 500 fell 50% peak to trough). This makes sense
to us
given the aforementioned run-up and higher fixed cost nature of the rail
industry.
To this point, earnings for the group were down 26% on average in 2009 on a
19% reduction in revenue. We note that CSX declined the most peak to trough
EFTA01415912
in
2008/09 (due to its run-up ahead of the recession) followed by CP as
Consensus
EPS forecasts for 2009 fell 56% vs. 37% on avg. for the rest of the group.
Deutsche Bank Securities Inc.
Page 35
EFTA01415913
31 October 2017
Railroads
Canadian Rails
Figure 74: Railroad stocks underperformed the market during the 08/09
recession
100
120
140
160
180
200
20
40
60
80
0
Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11
UNP
CNI
CSX
CP
S&P 500
Following the 08/09 recession, rails had another good run with CP and UNP
outperforming the rest of the industry. This was driven by two factors:
stronger
earnings growth and multiple expansion on the back of significant margin
improvements. We note that NTM P/E multiples for CP and UNP expanded by
40% and 30% during this time, respectively, compared to 20% for the rest of
the
industry and the S&P 500.
Figure 75: Solid margin expansion at CP and UNP supported stronger EPS
growth and higher P/E multiples from 2011-2014
100
150
200
250
300
350
400
50
0
Oct-11
Apr-12
Oct-12
Apr-13
Oct-13
Apr-14
Oct-14
EFTA01415914
CP
UNP
S&P 500
CNI
CSX
NSC
After peaking in late 2014 / early 2015, railroad shares declined 40% on
average
from peak to trough (vs. an essentially flat S&P 500 during that time) amidst
industry-wide carload declines due to weak industrial activity and a
significant
decrease in coal demand. We note that CP was the worst performing railroad
peak to trough (-50%) given its higher exposure to energy related carloads
while
CNI outperformed (-31%) given its undersized exposure to coal and Canadian
crude. Railroad shares began to recover in late 2015 / early 2016 as fears
over
further volume declines subsided. Performance was relatively similar across
the
board until Hunter Harrison left CP to join CSX. Since then, CSX has been the
Page 36
Deutsche Bank Securities Inc.
EFTA01415915
31 October 2017
Railroads
Canadian Rails
clear outperformer as investors anticipate significant margin improvement
and an
inflection in free cash flow.
Figure 76: Railroads with more energy/coal exposure faired poorly in 2015
100
120
140
160
40
60
80
Oct-14
Apr-15
Oct-15
Apr-16
Oct-16
Apr-17
CSX
S&P 500
NSC
UNP
CNI
CP
Oct-17
U.S. Class I rails (CP, NSC, UNP) currently trade on average at 19.3x NTM
EPS,
which is about a 30% premium to the average this decade (14.6x). Relative to
the S&P 500, the U.S. Class I's are trading at 1.07x, which is a 9% premium
to
their historical average (0.98x). The relative premium makes sense, in our
view,
given the outsized benefit from potential tax reform that U.S. railroads
would see
compared to the rest of the S&P 500. Canadian Class I rails currently trade
at
18.5x NTM EPS, translating to a 17% premium to the average this decade
(15.8x).
On a relative basis, however, the Canadian rails are trading at 1.02x the
S&P 500,
4% below their historical average (1.07x).
Figure 77: U.S. Class I rail historical valuation
10x
12x
14x
16x
18x
20x
EFTA01415916
22x
U.S. Class I NTM P/E
Relative to SPX (NTM)
60%
70%
80%
90%
100%
110%
120%
130%
Figure 78: Canadian rail historical valuation
10x
12x
14x
16x
18x
20x
Can. Class I NTM P/E
Relative to SPX (NTM)
60%
70%
80%
90%
100%
110%
120%
130%
Deutsche Bank Securities Inc.
Page 37
Jan-10
Sep-10
May-11
Jan-12
Sep-12
May-13
Jan-14
Sep-14
May-15
Jan-16
Sep-16
May-17
Jan-10
Sep-10
May-11
Jan-12
Sep-12
May-13
Jan-14
EFTA01415917
Sep-14
May-15
Jan-16
Sep-16
May-17
EFTA01415918
31 October 2017
Railroads
Canadian Rails
Rating
Buy
North America
Canada
Industrials
Railroads
Reuters
CP.N
Bloomberg
CP US
Shifting Gears; Initiate Buy/$209 price
target
Following its multi-year implementation of Precision Railroading, CP is
shifting
gears from cost take-out to top-line growth. As such, we see at least 15%
upside in shares as CP leverages its reduced cost base, improved service
levels,
and recent capacity investments to retake market share. We expect this to
translate to 30% cumulative EPS growth over the next two years, reflecting
midsingle
digit revenue growth, significant operating leverage, and accelerated share
repurchase. Against this backdrop we see CP's relative valuation discount as
unsustainable, which underpins our positive stance to shares. Initiate Buy.
CP is putting the pieces together to leverage a better network
After bringing its cost base closer in-line with CNI, CP has undertaken a
number
of initiatives aimed at growing its top-line and taking market share.
Further, it has
made a number of capacity investments in order to improve service levels and
more profitably handle volume growth across its network and reinvigorated its
sales/marketing efforts to expand existing relationships and win new
business. At
the end of the day, we believe CP is poised to drive best in class volume
growth
and increase operating leverage as it targets higher margin business. To
this point,
we forecast volume growth (measured by revenue ton-miles [RTM's]) to increase
at a 3.1% CAGR over the next two years compared to 2.4% CAGR at CNI. In
addition to CP's company-specific initiatives, we see outsized tailwinds for
CP's
domestic intermodal, crude by rail, and potash businesses which support our
view
of best-in-class volume growth.
CP's discounted valuation does not reflect earnings potential
CP currently trades at 17.5x NTM EPS estimates, which is about 3% below its
5year
avg. and nearly 10% below CNI's current multiple. CP's de-rating (both on
an absolute and relative basis) has coincided with a 20% decline in
EFTA01415919
merchandise
volumes from 2014 to 2017E while CNI's merchandise RTM's are now back inline
with 2014 levels. Given our expectation for CP to generate best-in-class RTM
growth over the next several years, we see potential for shares to re-rate
higher
as improved operating leverage translates to higher earnings growth.
Valuation and risks
Our $209 price target is based on 17.5x our 2019 EPS estimate, which is
supported by our DCF framework (3.75% terminal growth and 7.9% WACC).
Downside risks include a sharp decline in commodity prices, lower pricing,
NAFTA, and recession.
Company
Canadian Pacific
Seldon Clarke
Associate Analyst
Price at 30 Oct 2017 (USD)
Price Target
52-week range
Price/price relative
200
180
160
174.74
209.00
177.61 - 139.33
140
120
100
80
Jan '16
Apr '16
Jul '16
Canadian Pacific
Oct '16
Jan '17
Apr '17
TSE Composite (Rebased)
Jul '17
Oct '17
Performance
(%)
Absolute
TSE
Composite
Stock & option liquidity data
Market Cap (USD)
Shares outstanding (m)
Free float (%)
EFTA01415920
Volume (30 Oct 2017)
Option volume (und. shrs., 1M avg.)
lm
4.0
2.4
3m
10.7
5.8
12m
22.2
8.2
25,418.3
145.5
100
73,246
42,935
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31 October 2017
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Forecasts and ratios
Year End Dec 31
1Q EPS
2Q EPS
3Q EPS
4Q EPS
FY EPS (CAD)
P/E (x)
DPS (CAD)
Dividend yield (%)
Revenue (CADm)
2016A
2.50
2.04
2.73
3.04
10.29
17.5
0.00
0.0
6,232.0
2017E
2.50A
2.77A
2.90A
3.29
11.44
19.6
0.00
0.0
6,543.1
2018E
2.82
3.08
3.42
3.79
13.14
17.1
0.00
0.0
6,831.3
2019E
14.95
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15.0
0.00
0.8
7,265.1
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CP Company Overview
Canadian Pacific — headquartered in Calgary, Canada, was formed as a
passenger
rail shortly after Canada's confederation in 1867 to connect the eastern
provinces of Nova Scotia and New Brunswick with Canada's central provinces
of Quebec and Ontario. A few years later, Manitoba joined the confederation
with the promise that a transcontinental railroad would be built within 10
years.
Construction of the railway was challenged in the coming years before a group
of businessmen formed a viable syndicate and incorporated The Canadian
Pacific
Railway in 1881. Less than ten years later, CP provided coast to coast
passenger
service in Canada as well as a number of other services related to trade.
By 1986, Canadian Pacific had grown into Canada's second largest company
with $15 billion of revenue through a number of different subsidiaries. With
CEO
William Stinson at the helm in 1990, CP purchased the remaining interest in
the
Soo Line which operated in the U.S. Midwest and then acquired Delaware and
Hudson Railway (D&H) out of bankruptcy in 1991 which gave it access to ports
in the Northeast U.S. In 2001, the company spun out its five subsidiaries
into
separate companies and shares of Canadian Pacific began trading on the NYSE
and Toronto Stock Exchange.
In June, 2012 CP hired railroad legend Hunter Harrison as CEO in response
to activism efforts from Pershing Square. After acquiring a 14.2% stake in
the company, Pershing Square was able to reconstitute the board and appoint
Harrison as CEO. Rail operations at CP underwent a massive overhaul under
the direction of Harrison resulting in over 20 percentage points of margin
improvement over a five year span (19% in 2011 to 41% in 2016). During this
time
Harrison looked to merge with both CSX and NSC but could not find a friendly
path forward with either company. Harrison abruptly left the company in 2017
and became the CEO of CSX a few months later.
Today Canadian Pacific operates over 12,000 miles of railroad spanning six
Provinces in Canada and 13 states in the U.S. In 2017, we expect the company
to generate $6.5 billion of revenue and $2.7 billion of operating profit
(42% ebit
margin).
Figure 79: CP System Map
Canadian Pacific operates over 12,000 miles
of railroad spanning six Provinces in Canada
and 13 states in the U.S.
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Revenue Trends
Revenue at CP has increased at a 3.4% CAGR since 2000 due almost entirely to
growth in revenue per carload (aka yields; +3.2% CAGR) as carload growth has
been somewhat limited (+0.3% CAGR). CNI's yield growth reflects core pricing
gains as well as a longer length of haul as revenue ton-miles have actually
increased at a 1.3% CAGR over that time. The largest contributors to revenue
growth have been industrial and consumer products (9.1% CAGR) and grain (4.3%
CAGR) which help offset declines in fertilizers and sulphur (-2.5% CAGR) and
forest products (-1.8% CAGR). In 2016, CP generated C$6.28 in revenue,
marking
a 7.2% yoy decline from 2015.
Figure 80: CP Revenue Breakdown FY2016
Metals, Minerals,
Consumer Products
9%
Auto
6% Intermodal
22%
Forest
Products
4%
Fertilizers & Sulphur
5%
Potash
6%
Energy, chems,
plastics
14%
Coal
10%
Total Operating Revenue
YoY Change
Figure 81: CP Revenue Trends & YoY Changes
Grain
24%
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
0
6%
5%
EFTA01415925
4%
-7%
(20%)
(15%)
(10%)
(5%)
0%
5%
10%
15%
Revenue for CP is fairly straight forward at a high level - volume (measured
in
carloads) and yield (measured in avg. revenue per carload). Carload yields
can vary
significantly depending on a number of factors including mix of volume,
length of
haul, movements in core/underlying price, fuel surcharges, and currency. In
2016,
CP moved just over 2.5M carloads earning an average of C$2,400 in revenue/
carload. Below we highlight CP's exposure by carload and the corresponding
revenue the company generated on those particular carload classifications.
Figure 82: CP Carload Breakdown
Metals, Minerals,
Consumer Products
8%
Energy, chems, plastics
10%
Forest
Productsl
Fertilizers & Sulphur
2%
Potash
4%
Coal
12%
Grain
17%
Auto
5%
Intermodal
39%
Figure 83: CP Revenue per Carload by Commodity
(2016A)
1,000
2,000
3,000
4,000
5,000
0
EFTA01415926
4,757
4,154
3,433
2,904
1,990
1,343
3,394
2,880 2,814
2,400
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Revenue ($ millions)
YoY Change
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31 October 2017
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Total carload volumes have increased at a 0.3% CAGR since 2000, but declined
0.4% CAGR since 2006. The decline has largely been driven by sulphur and
fertilizers (-10.4% CAGR) and forest products (-6.9% CAGR) which offset solid
growth in industrial and consumer product carloads (5.9% CAGR).
Interestingly,
however, those commodities which saw the largest carload declines exhibited
the
strongest yield growth - sulphur and fertilizers rev/carload increased 6.8%
CAGR
and forest products increased 5.9% CAGR - as CP elected to move more
profitable
freight. Overall revenue per carload has increased at a 3.6% CAGR since 2006.
In the figures below we provide historical and our forecasted carload and
yield
trends followed by a more granular breakdown of CP's key commodity groups
and our thoughts moving forward.
Figure 84: CP Carload Growth (2005-2019E)
2,000
2,250
2,500
2,750
3,000
Total Carloads
4%
-4%
4%
3%
(20%)
(15%)
(10%)
(5%)
0%
5%
10%
15%
YoY Change
Figure 85: CP Revenue per Carload (2005-2019E)
1,000
1,250
1,500
1,750
2,000
2,250
2,500
2,750
Revenue per carload
EFTA01415928
3%
1%
1%
-4%
(5%)
0%
5%
10%
15%
YoY Change
Commodity breakdown
Below we breakdown the key revenue categories for CP and the drivers behind
them.
Grain - the largest revenue contributor for CP accounting for 24% of total
revenue
in 2016. Grain revenue has increased at a 5.0% CAGR since 2006 amidst modest
volume growth (1.2% CAGR) and strong improvement in yields (+3.8% CAGR). We
note that roughly 2/3 of CP's grain business is Canadian grain which is
transported
from the Canadian Prairies (Alberta, Saskatchewan, Manitoba) to Canadian
ports
for export and to eastern Canada, the U.S. and Mexico for domestic
consumption.
Roughly 70% of that grain is regulated by the Canadian government via the
Canada Transportation Act (CTA) which carries an annual revenue cap. The
remaining third of grain revenue comes from the U.S which is used for both
exports and domestic consumption. Recently, it has been a tale of two
stories as
U.S. grain volumes were down 24% yoy in the most recent quarter while
Canadian
grain volumes were up 4% yoy. While current crop forecasts are calling for a
nearly 10% reduction in Canadian grain production in the 2017/18 crop year,
we
believe increased demand for CP's dedicated train program will help offset
some
of these headwinds.
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Deutsche Bank Securities Inc.
Carloads (000's)
YoY Change
Revenue per Carload
YoY Change
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31 October 2017
Railroads
Canadian Rails
Figure 86: Grain as a % of Total Revenues
Canada
65%
All Other
76%
Grain
24%
U.S.
35%
CP's dedicated grain train program has
been a major focus in recent years for CP.
This has helped drive increased demand
for the product which was up 15% yoy
in 3Q amidst 16% faster cycle times. We
believe increased demand for this service
will help offset near-term headwinds from
lower grain production.
Intermodal - accounted for roughly 22% of CP's revenue in 2016. Intermodal
revenue has increased at just 0.4% CAGR since 2006 as volumes have declined
in three of the last four years (-1.7% CAGR since '06) and largely offset
modest
growth in yields (2.2% CAGR). CP's Domestic intermodal volumes, which contain
a variety of goods (largely consumer related), accounted for 55% of CP's
total
intermodal revenue last year while International intermodal volumes, which
consists of containerized imports and exports, made up the remaining 45%.
CP's
intermodal franchise has access to three key coastal ports - the Port of
Vancouver
(71% of international revenue), Port of Montreal (23% of international
revenue),
and New York/New Jersey. We believe Intermodal represents the largest growth
opportunity of any commodity for CP over the next several amidst increased
truckto-rail
conversions and easy comps.
Figure 87: Intermodal as a % of Total Revenues
Domestic
55%
All Other
78%
Intermodal
22%
Interational
45%
Poor service levels have resulted market
share loss to truckload at CP's domestic
intermodal business in recent years. With
EFTA01415930
avg. train speeds up 14% since 2014 and
a more transparent service offering for
shippers, we see significant tailwinds for
CP's domestic intermodal business over the
next several years.
Energy, Chemicals, & Plastics - accounted for 14% of CP's revenue in 2016
Demand for this segment stems largely from oil and gas activity in North
America
with the majority of energy related commodities originating in Western
Canada.
However, CP has a number of rail interline partnerships which give it access
to refineries and export facilities in other parts of North America,
including the
Louisiana petrochemical corridor. As shown below, the largest contributor to
this
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31 October 2017
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business comes from energy (46%), with chemicals (23%), biofuels (22%) and
plastics (9%) making up the remainder. In 2016, energy, chemicals, and
plastics
revenue fell 23% yoy amidst a 65% decline in crude revenue. Recently, however
things have turned around as revenue is up 2% ytd and we expect momentum to
continue through 2018 & 2019 amidst strong crude by rail demand.
Figure 88: Energy, Chemicals, & Plastics as a % of Total Revenue
Chemicals
23%
All Other
86%
Energy, Chems &
Plastics
14%
Energy
46%
Biofuels
22%
Plastics
9%
We see significant tailwinds for energy,
chemicals and plastics at CP due to
increased demand for crude by rail volumes.
We note that the Canadian Association
of Petroleum Producers estimates that the
supply of oil from Western Canada will
increase at a 3.6% CAGR from 2017-2020
to over 4.5 million barrels per day, well
in excess of current pipeline capacity of
4M bbl/day. We believe this dynamic will
support crude by rail volumes in 2018 &
2019.
Coal - accounted for 10% of CP's revenue in 2016. The majority of coal hauled
by CP is metallurgical coal which is exported to regions like Asia to be
used for
steelmaking. These shipments generally originate from Teck Resource Limited's
coal mines located in western Canada and move to port terminals on the west
coast. To this point, coal has the 2nd shortest length of haul for CP - 580
miles
vs. the company avg. of 853 - which translates to a lower revenue per carload
- C$1,990 vs. company avg. of C$2,400. The remainder of CP's coal business
is largely thermal coal which is consumed domestically in North America. Coal
revenue has been essentially flat since 2006 (0.2% CAGR) as volumes have
fallen
off in recent years due to cheaper nat gas prices. To that point, coal
revenue fell
5.2% yoy in 2016 amidst a 5.7% decline in carloads.
EFTA01415932
Figure 89: Coal revenue as a % of Total Revenue
The outlook for coal at CP is moderately
better than U.S. rails given its outsized
exposure to metallurgical coal, which is
expected to be more stable than domestic/
thermal coal in the coming years.
All Other
90%
Coal
10%
Canadian Export
84%
Canadian
Domestic
6%
U.S. Domestic
10%
Metals, Minerals, Consumer Products - accounted for 9% of CP's revenue in
2016. There are a variety of commodities within this group with ties to oil
and gas
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31 October 2017
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development, non-residential construction, auto's, and the consumer. It has
been
fairly volatile in recent years due to the swings in commodity prices with
volumes
down 14% and 10% in 2015 and 2016, respectively. YTD, however, things have
recovered and volumes are up over 30% YTD (through 3Q) due largely to
increased
demand for frac sand and steel. Additionally, CP has enhanced its cold-chain/
refrigerated capabilities through the purchase of over 40 gensets,
containers with
power generators capable of powering 17 cold-storage containers, which we
expect to contribute to growth in the coming years.
Figure 90: Metals, Minerals, & Consumer Products as a % of Total Revenues
Sand & stone
25%
All Other
91%
Metals, minerals &
consumer products
9%
Other aggregates
25%
Steel
30%
Food &
consumer
15%
Metal &
minerals
1%
Potash - accounted for 6% of CP's freight revenue in 2016. The majority of
potash
volumes originate in Saskatchewan (Western Canada) and are exported through
various ports served by CP. All export shipments of potash are marketed by a
JV of Seskatchewan's potash producers called Canpotex Limited while domestic
moves are handled independently. Potash revenue is up nearly 30% YTD for CP
amidst strong growth in both volume and yields. We expect potash carloads to
grow double digits for the next few quarters as volumes ramp up from the
recently
opened K+S Potash Canada Mine.
Figure 91: Potash as a % of Total Revenue
We expect potash carloads to grow double
digits for the next few quarters as volumes
ramp up from the recently opened K+S
Potash Canada Mine.
Domestic
46%
EFTA01415934
All Other
94%
Potash
6%
Export
54%
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31 October 2017
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Profitability trends
CP reported operating income of C$2.6bn in with a company-best and near best
in class operating ratio of 58.6% in 2016. Over the past ten years, CP's EBIT
has increased at an 8.6% CAGR on just 3.1% revenue CAGR as the company
was able to reduce its operating ratio by nearly 1,700bps. The majority of
this improvement came during Hunter Harrison's tenure as CEO (see figure
below) when the operating ratio improved 1,600bps from 2012-2016. Harrison's
Precision Railroading model helped transform CP through a relentless focus
on asset optimization, network connectivity, and cost controls. To put this
into context, CP reduced its locomotive fleet size by 40% from 2012 to 2015
while maintaining volume levels. Said another way, CP was able to improve
its locomotive productivity by 40% in three years by removing older units
from circulation and running heavier/longer trains. Another aspect of
Precision
Railroading involves the replacement of hump yards with flat-switching. This
change helped CP improve its average terminal dwell (the time a train spends
at
a terminal) by 19% and average network speed by 40% since 2011. We expect
continued improvement in margins as CP benefits from strong operating
leverage
to volume growth.
Figure 92: CP EBIT & YoY Changes (2005-2019E)
1,000
1,500
2,000
2,500
3,000
3,500
500
0
Operating Income
7% 8%
9%
-2%
(40%)
(30%)
(20%)
(10%)
0%
10%
20%
30%
40%
50%
YoY Change
Figure 93: CP Operating Ratio trends since 2005
EFTA01415936
50%
55%
60%
65%
70%
75%
80%
85%
90%
Harrison appointed
CEO
Balance Sheet & Cash Flow overview
As of Q3 2017, CP's net debt totaled C$7.9bn (excluding C$288 million of
offbalance
sheet debt) and its net debt/ebitda ratio was 2.4x. Historically, CP's net
debt/ebitda has averaged 2.5x and remained within a range of 1.6-3.2x
(hitting
3.2x in 2009 and 2011). This is modestly higher than its Class I peers under
our
coverage universe which typically run a leverage ratio around 2.0x.
Management
targets a long-term leverage ratio of 2-2.5x. In the figure below we depict
CP's
gross and net debt balances as well as its leverage ratio since 2005.
Page 46
Deutsche Bank Securities Inc.
EBIT ($ millinos)
YoY Change
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
77.0%
2017E
2018E
2019E
58.0%
56.7%
55.6%
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31 October 2017
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Figure 94: CP debt levels and leverage ratios (2005-2019E)
10,000
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
0
Gross Debt
Net Debt
Net debt/ebitda
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
3.0x
3.5x
Over the past ten years, CP's net capex averaged 18.3% of revenue on an
annualized basis and has primarily been used for network maintenance, rail
siding, and rail equipment. That number declined to 17% in 2016 after CP
completed a multi-year track upgrade program in 2015. Management expects
capex to increase 6% yoy in 2017 to C$1.25bn due to increased Positive Train
Control (PTC) spending for portions of its U.S. network and we see this
increasing
to C$1.3-1.4bn in the following years as CP updates its grain hopper fleet.
Since
Harrison took the reigns as CEO in 2012, CP has drastically improved its
free cash
flow conversion as free cash flow increased nearly four-fold from 2012-2016.
We
forecast over 40% cumulative free cash flow growth by 2019 (vs. 2017).
Figure 95: FCF and FCF as a % of Net Income (2005-2019E)
69%
1,400
79%
(600)
(100)
400
900
Free Cash Flow
EFTA01415938
% of NI
82%
(150%)
(100%)
(50%)
0%
50%
100%
CP recently started returning more cash to shareholders with a massive
buyback
in 2014-15 which resulted in a nearly 10% reduction in the company's
sharecount.
Deutsche Bank Securities Inc.
Page 47
Free Cash Flow ($ Millions)
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017E
2018E
2019E
% of NI
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31 October 2017
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Historically the company has paid a steady dividend which has increased at
10%
CAGR over the past ten years.
Figure 96: CP has increased cash returned to shareholders in recent years
1,000
1,500
2,000
2,500
3,000
500
0
Repurchase of common stock
Dividends paid
% of NI
94.6%
78.5%
78.7%
82.2%
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
Management Overview
Keith Creel — President & CEO
■
Keith joined CP in 2013 as the Chief Operating Officer and was appointed
to CEO and President of CP in January 2017 after the departure of Hunter
Harrison
■
Previously, Keith served as Executive Vice President and COO of
Canadian National after joining the company in 1999 through the
company's merger with Illinois Central Railroad
■
Keith began his career in railroading in 1992 at BNSF as an intermodal
ramp manager
Nadeem Velani — Vice President & CFO
■
■
Nadeem was appointed Vice President and CFO in October, 2016 after
serving as Vice-President Investor Relations for a little over three years
EFTA01415940
Roughly 18 years of railroading experience
Robert Johnson — Executive Vice President, Operations
■
■
Industry veteran of 30+ years
Served in current role since 2016 after serving as Vice-President
Operations, Southern Region
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Deutsche Bank Securities Inc.
Cash Returned to shareholders
% of NI
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31 October 2017
Railroads
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Figure 97: Share capital concentration
Others
89%
Causeway
3%
RBC
4%
Artisan Partners
4%
Artisan Partners
RBC
Causeway
Others
Valuation
Shares of CP have performed nicely YTD - up 23% compared to +26% for the
group (21% ex-CSX) and 15% for the S&P 500. The stock currently trades at
17.5x
NTM P/E, which is about half a turn below its 5-year average, but well above
where it was trading prior to the appointment of Hunter Harrison as CEO.
Relative
to its peers, CP trades at a 7% discount, though this is partially due to
the outsized
impact that U.S. tax reform would have on CSX, NSC, and UNP. Nonetheless,
we expect the relative valuation to essentially reverse in 2018 as CP's
earnings
trajectory improves.
Figure 98: CP historical forward P/E multiples
Fwd. P/E
10-Yr avg.
15-Yr. Avg.
5-Yr Avg.
Figure 99: CP is trading below its Class I peers
12x
17x
22x
27x
7x
'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17
10x
12x
14x
16x
18x
20x
22x
24x
EFTA01415942
'12
'13
CP
'14
CNI
'15
'16
U.S. Class I's
'17
On an EV/EBITDA basis, CP currently trades at trades at 11.4x EV/EBITDA,
which
is modestly above its 5-year average.
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31 October 2017
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Figure 100: CP's historical EV/EBITDA multiple trends
10.0x
10.5x
11.0x
11.5x
12.0x
12.5x
13.0x
13.5x
14.0x
14.5x
8.0x
8.5x
9.0x
9.5x
EV/EBITDA
5-Yr. Avg.
Page 50
Deutsche Bank Securities Inc.
Aug-12
Nov-12
Feb-13
May-13
Aug-13
Nov-13
Feb-14
May-14
Aug-14
Nov-14
Feb-15
May-15
Aug-15
Nov-15
Feb-16
May-16
Aug-16
Nov-16
Feb-17
May-17
Aug-17
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31 October 2017
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Financial Statements
Figure 101: CP Income Statement
Canadian Pacific Railway (CP)
Quarterly Income Statement (C$ millions)
Operating Revenue
Total rail freight revenues
YoY Change
Other revenues
YoY Change
Total Operating Revenue
YoY Change
Operating Expenses
Compensation and benefits
Fuel
Materials
Equipment rents
Depreciation and ammortization
Purchased services and other
Total Operating Expenses
YoY Change
Operating Ratio (OR) Gross Of Fuel
YoY Improvement (deterioration)
Operating Income
YoY Change
Incremental Margin
Other Income And Interest Expense
Other income
Interest expense
Total other income
Pretax income before income taxes
Effective income tax rate
Income taxes
Net income (continuing)
Extraordinary items
Net income (reported)
YoY Change
Diluted EPS (Continuing)
Extraordinary items
Diluted EPS (Reported)
YoY Change (continuing)
Avg. basic shares outstanding
Avg. diluted shares outstanding
(37)
(276)
(313)
2012
2012
EFTA01415945
5,550
145
2013
2013
5,982
151
2014
2014
6,464
156
2015
2015
6,552
2016
2016
6,060
9.9% 7.8% 8.1% 1.4% (7.5%)
160
172
6,133
6,620
6,712
6,232
10.0% 7.7% 7.9% 1.4% (7.2%)
1,486
999
238
206
539
918
4,386
1,378
1,004
160
173
565
998
4,282
4.2% (2.4%)
1,348
1,048
193
155
552
985
4,281
(0.0%)
1,371
708
184
174
EFTA01415946
595
1,060
4,092
(4.4%)
1,189
567
180
173
640
905
3,654
(10.7%)
3/31/2017 6/30/2017 9/30/2017 12/31/2017
01 2017 Q2 2017 Q3 2017 Q4 2017e
1,563
16.7% 4.1% 3.3% 2.6% 7.5% (7.0%)
5,695
1,603
284
170
49
36
166
278
983
1,598
45
1,547
48
1,660
43
2017
2017E
6,368
176
2018
2018E
6,648
183
2019
2019E
7,070
1.0% 13.7% 2.5% 4.0% 5.1% 4.4% 6.4%
40
195
1,643
2.3% 9.1% 4.0% 2.1% 4.4% 6.4%
1,595
1,702
277
160
EFTA01415947
48
37
165
277
964
256
150
45
35
162
257
905
255
177
43
39
167
264
944
6,543
1,072
657
185
147
660
1,076
3,796
6,831
1,092
699
185
157
683
1,055
3,872
7,265
0.8% 13 3% 2.6% 4.0% 5.0% 4.4% 6.4%
1,129
745
189
167
719
1,090
4,039
4.8% 7.2% 0.9% 2.6% 3.9% 2.0% 4.3%
77.0% 69.8% 64.7% 61.0% 58.6% 61.3% 58.7% 56.7% 55.5% 58.0% 56.7% 55.6%
432 bps 720 bps 515 bps 370 bps 233 bps (237 bps) 333 bps 98 bps 75 bps 62
bps 134 bps 108 bps
1,309
1,851
2,339
EFTA01415948
2,620
123.7% 100.2% 305.4%
(17)
(278)
(295)
(7)
(282)
(289)
19
(394)
(375)
2,578
35.5% 41.4% 26.4% 12.0% (1.6%)
620
679
690
758
2,747
2,960
3,226
(5.1%) 23.2% 5.0% 5.8% 6.6% 7.7% 9.0%
NM (275.0%) 66.3% 80.5% 63.4% 54.4% 73.7% 61.4%
(9)
(471)
(480)
996.0 1,556.0 2,050.0 2,245.0 2,098.0
417.0
564.0
620.0
549.0
50.0
0
(120)
(120)
500.0
132.0
(3)
(122)
(125)
554.0
147.0
0
(115)
(115)
575.0
25.2% 26.8% 27.5% 27.6% 26.2% 26.4% 26.5% 26.6%
251.3
153.0
744.7 1,139.0 1,486.0 1,625.0 1,549.0
(260.7)
(257.0)
EFTA01415949
484.0
$4.30
($1.51)
$2.80
171.8
173.1
(6.0)
(273.0)
882.0 1,480.0 1,352.0 1,599.0
(15.1%) 52.9% 30.5% 9.4% (4.7%)
$6.45
($1.46)
$5.00
174.9
176.5
$8.52 $10.09 $10.29
($0.03)
$8.49
172.8
174.4
159.8
161.0
($1.70) $0.33
$8.40 $10.62
149.6
150.5
368.0
63.0
431.0
$2.50
$0.43
$2.93
146.5
147.1
407.0
73.0
480.0
$2.77
$0.50
$3.27
146.5
146.9
422.0
88.0
510.0
$2.90
$0.60
$3.50
145.5
145.8
0
EFTA01415950
(116)
(116)
(3)
(473)
(476)
0
(468)
(468)
26.5% 26.5%
602.2
660.4
0.0
0
(483)
(483)
642.3 2,271.3 2,491.9 2,742.8
26.5%
170.2
224.0
26.5%
726.8
472.1 1,669.1 1,831.5 2,015.9
0.0
472.1
1,893.1 1,831.5 2,015.9
(4.2%) 30.4% 4.2% 5.4% 7.8% 9.7% 10.1%
$3.29 $11.44 $13.14 $14.95
$0.00
$1.54
$0.00
$3.29 $12.98 $13.14 $14.95
(16.3%) 50.0% 32.0% 18.5% 2.0% 0.2% 35.5% 6.2% 8.1% 11.2% 14.8%
143.4
143.7
145.5
145.9
139.1
139.4
134.5
134.8
$0.00
0.0
Deutsche Bank Securities Inc.
Page 51
13.8%
EFTA01415951
31 October 2017
Railroads
Canadian Rails
Figure 102: CP Balance Sheet
Canadian Pacific Railway Limited (CP)
Annual Balance Sheet (C$ millions)
Assets
Current Assets:
Cash and cash equivalents
Accounts receivable, net
Materials and supplies (11)
Deferred income taxes
Other current assets
Total Current Assets
Investments
Net property and equipment
Goodwill and Intangible assets
Other assets
Total Assets
Liabilities And Owner's Equity
Current Liabilities
Accounts payable and accrued liabilities
Short term borrowing
Income and other taxes payable
Dividends Payable
Current portion of long term debt
Total Current Liabilities
Long term Debt
Deferred income taxes
Pension and other benefits liabilities
Other long-term liablities
Total Liabilities
Shareholder's Equity
Total Liabilities And Equities
2012
2012
2013
2013
2014
2014
2015
2015
2016
2016
2017
2017E
2018
2018E
2019
2019E
EFTA01415952
333
546
136
254
60
1,329
83
161
141
887
580
165
344
53
2,029
92
1,450
226
702
177
56
116
1,277
112
176
637
650
645
188
0
54
1,537
152
211
1,464
164
591
184
0
70
1,009
194
202
1,127
130
621
192
0
73
1,015
199
EFTA01415953
202
3,371
288
648
198
0
77
1,210
204
202
5,455
416
689
206
0
82
1,392
209
13,013 13,327 14,438 16,273 16,689 17,264 17,856 18,462
162
202
7,968
14,727 17,060 16,640 19,637 19,221 22,052 24,928 28,233
1,176
0
0
0
54
1,230
4,636
2,092
1,366
306
9,630
5,097
1,189
0
0
0
189
1,378
4,687
2,903
657
338
1,277
0
0
0
134
1,411
EFTA01415954
5,659
2,773
755
432
5,610
1,417
0
0
0
30
1,447
8,927
3,391
758
318
4,796
1,322
0
0
0
25
1,347
8,659
3,571
734
284
4,626
1,373
0
0
0
25
1,398
8,779
3,682
699
284
7,210
1,401
0
0
0
25
1,426
8,899
3,811
680
284
1,461
0
0
EFTA01415955
0
25
1,486
8,994
4,013
662
284
9,963 11,030 14,841 14,595 14,842 15,100 15,439
7,097
9,828 12,794
14,727 17,060 16,640 19,637 19,221 22,052 24,928 28,233
Page 52
Deutsche Bank Securities Inc.
EFTA01415956
31 October 2017
Railroads
Canadian Rails
Figure 103: CP Cash Flow Statement
Canadian Pacific Railway Limited (CP)
Annual Cash Flow Statement (C$ millions)
Operating Activities:
Net Income
Adjustments to reconcile NI
Depreciation and ammortization
Deferred income taxes
Restructuring and environmental payments
Foreign Exchange gains and losses on LTD
Pension funding
Other operating activities,
Changes in working capital
Cash Flow From Operations
Investing Activities:
Capital investments
Proceeds from asset sales
Net capex
Acquisitions net of cash acquired
Proceeds from sale of properties and
Other investing activities, net
Cash Flow From Investing
Financing Activities:
Issuance of LTD
Net increase / (decrease)
Reduction of LTD
Dividends paid
Collecting of recievables from
Issuance of CP common shares
Repurchase of common stock
Other financing activities, net
Cash Flow From Financing
Effect of foreign currency
Cash and cash equivalents,
Net increase (decrease) in
Cash and cash equivalents,
2012
2012
484
539
140
315
0
(61)
(84)
(5)
1,328
(1,148)
net
in ST Debt
asset sales
financial intitutions
fluctuations
beginning of period
cash and cash equivalents
end of period
EFTA01415957
83
(1,065)
0
62
(8)
(1,011)
71
(27)
(50)
(223)
0
198
0
1
(30)
(1)
47
CHECK
286
333
2013
2013
875
565
212
423
0
(55)
(68)
(2)
1,950
(1,236)
73
(1,163)
0
0
(434)
(1,597)
0
(3)
(56)
(244)
0
83
(220)
10
333
143
476
2014
EFTA01415958
2014
1,476
552
354
0
0
(132)
(3)
(124)
2,123
(1,449)
52
(1,397)
0
638
9
(750)
771
(183)
(244)
0
62
0 (2,050)
0
14
(1,630)
7
476
(250)
226
2015
2015
1,352
595
234
0
0
(49)
52
275
2,459
(1,522)
73
(1,449)
0
342
(16)
(1,123)
3,780
0 (1,262)
(505)
EFTA01415959
(226)
0
43
(2,787)
0
(957)
45
226
424
650
2016
2016
1,599
640
320
0
(79)
(138)
(198)
(55)
2,089
(1,182)
116
(1,066)
0
0
(3)
(1,069)
0
(8)
(38)
(255)
0
21
(1,210)
(3)
(1,493)
(13)
650
(486)
164
2017
2017E
1,893
660
262
0
(300)
(140)
0
11
EFTA01415960
2,385
(1,235)
0
(1,235)
0
0
5
(1,230)
150
0
(30)
(309)
0
0
(1,000)
0
(1,189)
0
164
(34)
130
2018
2018E
1,832
683
287
0
0
(75)
0
(10)
2,716
(1,275)
0
(1,275)
0
40
0
(1,235)
150
0
(30)
(328)
0
0
(1,115)
0
(1,323)
0
130
158
EFTA01415961
288
2019
2019E
2,016
719
315
0
0
(75)
0
7
2,983
(1,325)
0
(1,325)
0
25
0
(1,300)
125
0
(30)
(349)
0
0
(1,300)
0
(1,554)
0
288
129
416
Deutsche Bank Securities Inc.
Page 53
EFTA01415962
31 October 2017
Railroads
Canadian Rails
Rating
Sell
North America
Canada
Industrials
Railroads
Reuters
CNI.N
Bloomberg
CNI US
A Victim of Their Own Success - Initiate
Sell/$73 price target
We see 10%+ downside in CNI shares as the company's strong outperformance
starts to slow- driven by both the law of large numbers (the company already
achieves a mid 40's operating margin, up from the high 30's five years ago)
as
well as catch-up performance from CP. For example, we note that from
2012-2016
CNI increased volumes at more than double the rate of CP, reflecting mix as
well
as market share gains during CP's implementation of Precision Railroading.
The
combination of CNI's slower prospective earnings growth and high capex (20%
of
sales) implies 15.5x P/E under our DCF-derived methodology, implying
potential
for three turns (15%) valuation de-rating vs. current trading levels.
Initiate Sell.
Market is giving CNI too much credit
We do not believe current valuation appropriately reflects the relative
earnings
trajectory and shifting market dynamics within the Canadian rail industry. To
this point, if we assume long-term capex of 20% of sales (inline with mgmt
guidance), our DCF analysis implies that CNI would need to generate 5%
topline
CAGR through 2025 to warrant current valuation. In an industry that we
anticipate organically grows revenue at a 3.5-4% CAGR long-term, market share
wins would need to continue at the same pace as recent years (essentially 2x
CP
from 2012-2016) for this to be achievable. This is quite unlikely, in our
view, as
Canadian Pacific (CP) has largely eliminated CNI's cost and service
advantage. In
fact, we anticipate a reversal in this trend amidst a natural rebalancing of
market
share in CP's favor.
Valuation and risks
Our $73 price target is based on 15.5x our 2019 EPS estimate, which is
EFTA01415963
supported
by our DCF framework (3.75% terminal growth rate and 8% WACC). Upside risks
include pricing and further market share wins.
Company
Canadian National
Seldon Clarke
Associate Analyst
Price at 30 Oct 2017 (USD)
Price Target
52-week range
Price/price relative
90
80
81.21
73.00
83.85 - 61.95
70
60
50
40
Jan '16
Apr '16
Jul '16
Oct '16
Canadian National
Jan '17
Apr '17
TSE Composite (Rebased)
Jul '17
Oct '17
Performance
(%)
Absolute
TSE
Composite
Stock & option liquidity data
Market Cap (USD)
Shares outstanding (m)
Free float (%)
Volume (30 Oct 2017)
Option volume (und. shrs., 1M avg.)
lm
-2.0
2.4
3m
2.6
5.8
EFTA01415964
12m
28.7
8.2
61,215.1
753.8
236,587
35,232
Page 54
Deutsche Bank Securities Inc.
EFTA01415965
31 October 2017
Railroads
Canadian Rails
Forecasts and ratios
Year End Dec 31
1Q EPS
2Q EPS
3Q EPS
4Q EPS
FY EPS (CAD)
OLD FY EPS (CAD)
% Change
P/E (x)
DPS (CAD)
Dividend yield (%)
Revenue (CADm)
2016A
1.00
1.11
1.25
1.24
4.60
-1 7.7
1.49
1.8
12,037.0
2017E
1.15A
1.33A
1.31A
1.28
5.07
-2 0.6
1.64
1.6
13,066.8
2018E
1.17
1.34
1.43
1.42
5.34
-1 9.5
1.81
EFTA01415966
1.7
13,417.6
2019E
5.90
17.7
1.99
1.9
14,171.0
Deutsche Bank Securities Inc.
Page 55
EFTA01415967
31 October 2017
Railroads
Canadian Rails
CNI Company Overview
Canadian National - headquartered in Montreal, Canada was created by the
government of Canada after World War I forced several smaller railroads into
bankruptcy. In order to maintain a fluid transportation system in Canada, the
government accumulated a number rail systems and created Canadian National
Railways (CNR) in December, 1918. In the years following, CNR took over
operations of several additional railways, including the Grand Trunk Railway
which is the incorporated name for the company's U.S. rail operations today.
CNR
remained under complete government subsidy until completing its initial
public
offering in November 1995.
Following its IPO the company, which was rebranded as Canadian National (CN),
remained acquisitive and completed an aggressive rationalization of its
network.
In 1998 CN purchased Illinois Central Railroad for $2.4 billion to improve
its
connectivity across Canada and into the U.S. Acting Illinois Central CEO
Hunter
Harrison was then appointed CEO of CN. In 1999, CN and BNSF announced that
the two companies planned to merge - forming North American Railways. The
merger was aggressively denounced by the other Class I rails and the Surface
Transportation Board issued a 15 month moratorium on rail mergers so it could
adopt new merger rules. This caused the companies to abandon the merger plans
and focus on network rationalization. Under the direction of Harrison, CN was
able to bring its operating ratio from 70% in 2001 into the low 60's before
Harrison
departed for CP in 2012.
Today Canadian National operates over 20,000 miles of railroad which connects
all four major ports in Canada (Prince Rupert, Vancouver, Halifax &
Montreal) to
the Gulf of Mexico. In 2017, we expect the company to generate roughly $13.1
billion of revenue and $5.7 billion of operating income.
Figure 104: CNI System Map
CNI's network spans roughly 20,000 miles
and provides service to all major Canadian
markets as well as 75% of the U.S.
population.
Page 56
Deutsche Bank Securities Inc.
EFTA01415968
31 October 2017
Railroads
Canadian Rails
Revenue Trends
The revenue model for CNI (as well as other railroad companies) is fairly
straight
forward at a high level - volume (measured in carloads) x yield (measured in
average revenue per carload). Revenue at CNI has increased at a 5.1% CAGR
since
2000 amidst modest growth in volumes (2.0% CAGR) and yields (2.9% CAGR).
The increase in yield reflects an average of 3.5%+ core pricing gains and a
longer
average length of haul. The largest contributors to revenue growth have been
intermodal (7.3% CAGR), metals and minerals (7.3% CAGR), and petroleum and
chemicals (+5.7%) while coal (1.8% CAGR) and autos (1.9% CAGR) have been
laggards. CNI's network, which connects three coasts in North America, and
its
exceptional service levels have helped it achieve the fastest top-line
growth of
any railroad under our coverage universe over the past decade (4.3% CAGR vs.
1.9% on avg. for other Class I's) with growth accelerating since 2010 (6.4%
CAGR
vs. 2.0% on avg. for other Class I's). In 2016, CNI generated just over
C$12B in
revenue marking a 4.6% yoy decline from 2015.
Figure 105: CNI Revenue Breakdown FY2016
Grain &
Coal
4%
Forest
products
16%
Petroleum
& chems
19%
fertilizers
18%
Intermodal
25%
Figure 106: CNI Revenue Trends & YoY Changes
10,000
12,000
14,000
16,000
2,000
4,000
6,000
8,000
0
Total Operating Revenue
EFTA01415969
9%
6%
3%
-5%
(15%)
(10%)
(5%)
0%
5%
10%
15%
20%
YoY Change
As we discussed above, revenue (at a high level) has essentially two inputs
- carloads and yield (rev/carload) Carload yields can vary pretty
significantly
depending on a number of factors including mix of volume, length of haul,
movements in core/underlying price, fuel surcharges, and currency. In 2016,
CNI
moved just over 5.2M carloads earning an average of C$2,176 in revenue per
carload. Below we highlight CNI's exposure by carload and the corresponding
revenue the company generated on those carload classifications.
Deutsche Bank Securities Inc.
Page 57
Revenue ($ Millions)
YoY Change
EFTA01415970
31 October 2017
Railroads
Canadian Rails
Figure 107: CNI Carload Breakdown
Forest
products
8%
Metals &
minerals
15%
Petroleum
& chems
12%
Auto's
5%
Coal
6% Grain &
fertilizers
12%
Intermodal
42%
Figure 108: CNI revenue per carload by classification
(2016A)
1,000
2,000
3,000
4,000
5,000
0
4,084
3,629
3,485
2,908
2,176
1,509
1,303
1,316
Total carload volumes have increased at a 0.8% CAGR since 2006 as strong
growth in intermodal (+5% CAGR) has been partially offset by declines in
forest
products (-4.1% CAGR) and metals and minerals (-1.9% CAGR) Interestingly,
however, those commodities exhibited some of the strongest yield growth -
forest
products rev/carload increased 4.5% CAGR and metals and minerals increased
5.9% CAGR - as CNI elected to move more profitable freight. Overall revenue
per
carload has increased at a 3.8% CAGR since 2006. In the figures below we
provide
historical carload and yield trends followed by a more granular breakdown of
EFTA01415971
CNI's key commodity groups and our thoughts moving forward.
Figure 109: CNI Carload Trends (2005-2019E)
2,500
3,000
3,500
4,000
4,500
5,000
5,500
6,000
6,500
Total Carloads
10%
3%
3%
-5%
(20%)
(15%)
(10%)
(5%)
0%
5%
10%
15%
20%
YoY Change
Figure 110: CNI Revenue per Carload Trends
(2005-2019E)
1,000
1,500
2,000
2,500
500
Total Revenue per Carload
2%
0%
-1%
-1%
(6%)
(4%)
(2%)
0%
2%
4%
6%
8%
10%
12%
YoY Change
EFTA01415972
Commodity breakdown
Below we breakdown the key revenue categories for CNI and the drivers behind
them.
Intermodal - accounted for 25% of CNI's revenue in 2016. Intermodal has been
the fastest growing segment for CNI with a ten-year CAGR of 7.4% (2006-2016)
due to a combination of strong volume growth (5% CAGR) and modest yield
Page 58
Deutsche Bank Securities Inc.
Carloads (000's)
YoY Change
Rev/Carload
YoY Change
EFTA01415973
31 October 2017
Railroads
Canadian Rails
growth (+2.3% CAGR). With connection to three coasts in North America,
roughly
2/3 of CNI's intermodal revenue comes from international volumes. CNI is the
only Class I railroad with access to the Port of Prince Rupert, which we
believe
should support high single-digit international intermodal growth in 2018. To
this
point, CNI has seen the strongest growth in intermodal volumes in 2017 (+15%
YTD through 3Q) with volumes accelerating in September (—+20% yoy) after the
Port of Prince Rupert completed its expansion project which increased
throughput
by 500k TEU's (+60% increase). Prince Rupert provides several advantages for
intermodal shippers including quicker transit times (2 day advantage over LA
and
1 day quicker than Vancouver) and lower port fees. Additionally, Prince
Rupert
had been gaining market share prior to its expansion from other west coast
ports
for U.S. bound intermodal volumes with roughly 50% of its imports destined
for
the U.S. compared to just 30% in 2009/2010. However, we believe international
intermodal moves are typically of lower margin, which is reflected in recent
yield
trends (-4% yoy in 3Q ex-currency), and we see potential headwinds to margins
in 2018 resulting from outsized international growth.
Figure 111: Intermodal as a % of Total Revenues
We believe CNI's international intermodal
volumes should continue to benefit from
the recent expansion at Prince Rupert.
However, we see potential headwinds
to margins from outsized growth in
international volumes.
All Other
75%
Intermodal
25%
International
63%
Domestic
37%
Petroleum & Chemicals - accounted for 19% of CNI's revenue in 2016. Demand
for this segment stems largely from oil and gas activity in North America
with the
majority of shipments originating near the Gulf of Mexico or Western Canada.
This
segment has been the 2nd fastest grower for CNI with a 10-year revenue CAGR
of 6.4% (2006-2016) due almost entirely to yield growth (6.2% CAGR) as
EFTA01415974
volumes
(0.2% CAGR) fell off in 2016 (-6.4% yoy) amidst reduced oil and gas
activity. Things
have turned around in 2017, however, with petroleum and chemicals carloads up
roughly 5% YTD (through 3Q). We see long-term tailwinds for chemical carload
growth at CNI due to the over supply of polyethelene coming out of the Gulf
which is where the majority of CNI's petroleum and chemical carloads
originate.
We note that chemical producers have commissioned facility investments that
are expected to result in a 35% increase in polyethelene capacity by 2020 and
+50% by 2025. This increase in supply is likely to far exceed domestic demand
growth, resulting in export opportunities for railroads serving the area.
Given CNI's
connection to west coast ports, we see them as one of the beneficiaries of
this
trend as they provide an outlet for excess polyethelene to be exported to
Asia.
Deutsche Bank Securities Inc.
Page 59
EFTA01415975
31 October 2017
Railroads
Canadian Rails
Figure 112: Petroleum & Chemicals as a % of Total Revenues
We see long-term tailwinds for chemical
carload growth due to increased demand
for polyethelene exports, though we do see
competition from other rails such as UNP in
this arena.
All Other
81%
Petroleum &
chems
19%
Refined petroleum
products
33% Crude &
condensate
17%
Chems & plastics
46%
Sulfur
4%
Grain & Fertilizers - accounted for 19% of CNI's revenue in 2016. Grain and
fertilizers revenue has grown at a 5.2% CAGR since 2006 due almost entirely
to a 5.1% yield CAGR as volumes have essentially remained flat. We note that
agriculture related carload growth can be somewhat volatile, however, and is
often dependent on the quality of crop production. For example, following a
record crop year in 2013/14 CNI's grain & fertilizer carloads were up nearly
12% in
2014. To this point, comps for the next few quarters will be challenging for
CNI as
we lap the record crop year in 2016/17. We note that roughly 68% of CNI's
grain
carloads originate in Canada, and the company moves roughly 52% of Canada's
total grain crop. Over the past few years, CNI has invested in new
locomotives
and longer-siding in order to accommodate longer trains which has helped the
company win new business. To that point, CNI's grain revenue ton miles
(RTM's)
increased 3% yoy in 2016 while CP's declined 3% yoy. While this trend
continued
into 2017, we have begun to see some weakness in CNI's grain volumes as RTM's
have declined yoy in five consecutive weeks.
Figure 113: Grain & Fertilizers as a % of Total Revenues
We see near-term headwinds for Grain
volumes amidst tough comps, a weaker
crop year, and our expectation for market
share losses due to a natural rebalancing of
grain shipments back to CP's network.
EFTA01415976
Feed grains
22%
All Other
81%
Grain &
Fertilizers
19%
Food grains
22%
Oilseeds
46%
Fertilizers
20%
Page 60
Deutsche Bank Securities Inc.
EFTA01415977
31 October 2017
Railroads
Canadian Rails
Forest Products - accounted for 16% of revenue in 2016. CNI is the largest
carrier
of forest products of any Class I rail in North America with roughly half of
its forest
product revenue tied to the U.S. and Canadian housing markets. Forest product
revenue has increased at just 0.3% CAGR since 2006 as declining carloads
(-4.1%
CAGR) have offset solid yield improvement (4.5% CAGR).
Figure 114: Forest Products as a % of Total Revenues
Pulp and paper
47%
All Other
84%
Forest
Products
16%
Lumber and
panels
53%
Metals & Minerals -accounted for 11% of revenue in 2016. Revenue for metals
& minerals has increased at a 3.8% CAGR since 2006 as strong growth in yields
(5.9% CAGR) has offset carload declines (1.9% CAGR). This dynamic is likely
due
to a longer length of haul for CNI's Metals & Mining business as its revenue
tonmiles
(RTMs) have actually increased at a 1 5% CAGR since 2006. Commodities
within this group are closely tied to oil and gas development, non-
residential
construction, and the auto industry. We note that Metals & minerals carloads
are
up nearly 30% ytd (through 3Q) due largely to stronger demand for frac sand
(up 100%+ yoy in 3Q) and drilling pipe. We expect growth to moderate in 2018,
however, due to tougher comps and increased sand competition from local mines
in Texas.
Deutsche Bank Securities Inc.
Page 61
EFTA01415978
31 October 2017
Railroads
Canadian Rails
Figure 115: Metals & Minerals as a % of Total Revenues
Increased oil and gas activity has resulted
in strong demand for frac sand and drilling
pipe. As a result, CNI's metals & mining
carloads were up nearly 30% ytd through
3Q.
Energy
Minerals
33%
All Other
89%
Metals &
Minerals
11%
Metals
46%
Materials
17%
Iron Ore
4%
Profitability trends
In 2016, CNI reported operating income of C$5.3 billion, which has grown at a
10% CAGR since 2010. The company had an operating ratio (OR) of 55.9%, the
lowest in company history and the lowest amongst all Class I rails. Further,
this
marks nearly 1,500bps of improvement from 2001's OR of 70.2%. We believe
a large driver behind CNI's best-in-class operating ratio is the result of
Hunter
Harrison's Precision Railroading model which he put in place during his
tenure as
CEO from 2003-2009. As you can see in the figure below, CNI's operating ratio
improved —300bps during this time (in spite of the great recession in
2008/9) and
has continued to improve as increased efficiencies have helped CNI maximize
incremental revenue growth. To this point, the company's incremental margins
averaged nearly 60% from 2010-2015. Looking forward, management expects
CNI's operating ratio to remain in the mid-50's over the next five years as
the
company plans to invest heavily and focus on top-line growth.
Figure 116: CNI EBIT & YoY Changes (2005-2019E)
1,000
2,000
3,000
4,000
5,000
6,000
7,000
EFTA01415979
0
Operating Income
1%
7%
3%
7%
(20%)
(10%)
0%
10%
20%
30%
YoY Change
Figure 117: CNI Operating Ratio Trends since 2005
Harrison retires in 2009
30%
40%
50%
60%
70%
80%
90%
Hunter Harrison appointed
President & CEO
Balance Sheet & Cash Flow overview
Page 62
Deutsche Bank Securities Inc.
EBIT ($ millions)
YoY Change
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018E
69.8%
61.8%
66.7%
56.5%
56.3%
55.7%
EFTA01415980
31 October 2017
Railroads
Canadian Rails
As of Q3 2017, CNI's net debt totaled C$10.58 excluding C$423M of off-balance
sheet debt. Historically, CNI has been a relatively low leverage company
with net
debt/ebitda averaging 1.5x since 2010. At the end of 2016, net debt/ebitda
was
slightly higher than it's long-term average at 1.65x. In the figure below we
depict
the company's gross and net debt balances as well as its leverage ratio since
2005.
Figure 118: CNI Gross Debt and Net Debt and leverage ratios (2005-2019E)
10,000
12,000
14,000
2,000
4,000
6,000
8,000
0
Gross Debt
Net Debt
Net Debt/ebitda
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
Over the past ten years, CNI's capex averaged 18.5% of revenue on an
annualized
basis and has primarily been used for network maintenance, additional rail
siding, and rail equipment. In 2015 and 2016, however, capex climbed to —22%
of sales as CNI made a number of investments in order to accommodate
growth and improve productivity. Investments included 90 new high-horsepower
locomotives. In 2017, the company expects capex to decline C$100M to C$2.68,
or 20% of sales, due to reduced investments in new equipment. Over the next
five years, management expects capex to remain roughly 20% of sales (vs.
maintenance capex of 15%) as the company looks to gain market share and
improve productivity largely through the use of new technologies. To this
point,
we expect CNI's free cash flow conversion to remain relatively stable at
current
levels.
Deutsche Bank Securities Inc.
Page 63
2005
2006
2007
EFTA01415981
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017E
2018E
2019E
EFTA01415982
31 October 2017
Railroads
Canadian Rails
Figure 119: FCF and FCF as a % of Net Income (2005-2019E)
1,000
1,500
2,000
2,500
3,000
3,500
4,000
500
0
Free Cash Flow
% of NI
71.2%
72.1%
72.9%
0%
20%
40%
60%
80%
100%
120%
CNI has done a good job of returning cash to shareholders through both
dividends
and share repurchases. Cumulatively, CNI has paid out over $8bn in dividends
and repurchased C$17bn worth of shares. Moreover, CNI has grown its dividend
payouts at a 13% CAGR over the past ten years. We expect the company to
return
80-85% of net income to shareholders over the next several years.
Figure 120: CNI returned nearly 90% of net income to shareholders in 2016
1,000
1,500
2,000
2,500
3,000
500
0
Repurchase of common stock
Dividends paid
% of NI
88%
84%
91%
93%
0%
20%
EFTA01415983
40%
60%
80%
100%
120%
140%
Page 64
Deutsche Bank Securities Inc.
Cash Returned to shareholders
Free Cash Flow ($ Millions)
% of NI
YoY Change
EFTA01415984
31 October 2017
Railroads
Canadian Rails
Management Overview
Luc Jobin — President & CEO
■
■
■
Luc was appointed CEO of CNI in July, 2016
Joined the company in 2009 as Executive VP & CFO
Luc has a diverse background and in his years prior to joining CNI served
as Executive VP of Power Corporation Canada
Mike Cory — Executive Vice President & COO
■
Mike joined CNI in 1981 as a labourer at a diesel shop in Winnipeg
and has held a number of different positions before being appointed
Executive VP and COO in July, 2016
■
Prior to becoming COO, Mike served in a number of roles including
customer service and marketing, a Superintendent, and as the General
Manager of Operations for the Michigan sub region
Ghislain Houle — Executive Vice President & CFO
■
Ghislain was appointed CFO in July, 2016 and has held a number of
positions at CNI in his 20-year tenure at the company
Figure 121: CNI Share capital concentration
Mass. Financial
Services
6%
RBC
4%
Others
77%
Cascade
13%
Cascade
RBC
Mass. Financial Services
Others
Valuation
Shares of CNI have performed well YTD - up 22% YTD, vs. +27% for the group
(+21% ex-CSX), and +15% for the S&P 500. The stock currently trades at 19.1x
Consensus NTM EPS, which is nearly 10% above its 5-year average and nearly
30% above its 15-year historical average. CNI is trading inline with its
U.S. peers
(despite the outsized impact U.S. tax reform would have on CSX, UNP, and
NSC) and 8% above CP. We believe current valuation implies that CNI's recent
market share wins will continue long-term which would suggest that CNI has an
Deutsche Bank Securities Inc.
Page 65
EFTA01415985
EFTA01415986
31 October 2017
Railroads
Canadian Rails
irreversible structural advantage over CP. We do not think this is the case,
and
expect CNI's multiple to revert closer to its historical 10-year average of
15.5x.
Figure 122: CNI trades well above its historical fwd. P/E
llx
13x
15x
17x
19x
21x
7x
9x
'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17
Fwd. P/E
15-Yr. Avg.
Figure 123: CNI trades inline with its U.S. peers but
nearly 10% above CP
-28%
15.0x
10x
12x
14x
16x
18x
20x
22x
24x
'12
'13
CP
'14
CNI
'15
'16
U.S. Class I's
'17
On an EV/EBITDA basis, CNI currently trades at 12.2x our NTM EBITDA estimate.
This represents a significant premium to the company's five year historical
average.
Figure 124: CNI's historical EV/EBITDA trends
10.0x
10.5x
11.0x
11.5x
12.0x
EFTA01415987
12.5x
13.0x
13.5x
8.0x
8.5x
9.0x
9.5x
EV/EBITDA
5-Yr. Avg.
Page 66
Deutsche Bank Securities Inc.
Aug-12
Nov-12
Feb-13
May-13
Aug-13
Nov-13
Feb-14
May-14
Aug-14
Nov-14
Feb-15
May-15
Aug-15
Nov-15
Feb-16
May-16
Aug-16
Nov-16
Feb-17
May-17
Aug-17
EFTA01415988
31 October 2017
Railroads
Canadian Rails
Financial Statements
Figure 125: CNI Income Statement
Canadian National Railway (CNI)
Quarterly Income Statement (C$ millions)
Operating Revenue
Total rail freight revenues
YoY Change
Other revenue
YoY Change
Total Operating Revenue
YoY Change
Operating Expenses
Labor and fringe benefits
Purchased services and material
Fuel
Depreciation and amortization
Equipment costs
Casualties and insurance
Total Operating Expenses
YoY Change
Opex as a % of revenue
Labor and fringe benefits
Purchased services and material
Fuel
Depreciation and amortization
Equipment costs
Casualties and others
Operating Ratio
YoY Improvement (deterioration)
Operating Income
YoY Change
Incremental Margin
Other Income And Interest Expense
Other income
Interest expense
Total other income
Pretax income
Effective income tax rate
Income taxes
Net income (continuing)
Extraordinary items
Net income (reported)
YoY Change (continuing)
Diluted EPS (Continuing)
Extraordinary items
Diluted EPS (Reported)
YoY Change (continuing)
Avg. basic shares outstanding
EFTA01415989
Avg. diluted shares outstanding
2012
2012
8,938
2013
2013
2014
2014
2015
2015
2016
2016
9,951 11,455 11,905 11,326
10.2% 11.3% 15.1% 3.9% (4.9%)
982
624
7.1% (36.5%)
679
706
711
9,920 10,575 12,134 12,611 12,037
9.9% 6.6% 14.7% 3.9% (4.6%)
1,952
1,248
1,524
924
249
338
6,235
2,182
1,351
1,619
980
275
295
6,702
2,319
1,598
1,846
1,050
329
368
7,510
2,406
1,729
1,285
1,158
373
394
7,345
EFTA01415990
8.8% 7.5% 12.1% (2.2%)
2,119
1,592
1,051
1,225
375
363
6,725
(8.4%)
3/31/2017 6/30/2017 9/30/2017 12/31/2017
Q1 2017 Q2 2017 Q3 2017 Q4 2017e
3,075
3,111
218
3,016
205
2017
2017E
2018
2018E
2019
2019E
3,106 12,308 12,637 13,346
8.1% 17.6% 7.2% 2.8% 8.7% 2.7% 5.6%
131
205
3,329
3,221
759
781
825
8.8% 4.0% 0.7% 10.1% 11.2% 2.0% 5.1% 6.8% 2.9%
3,206
3,311 13,067 13,418 14,171
8.2% 17.1% 6.9% 2.9% 8.6% 2.7% 5.6%
580
440
342
323
101
117
1,903
527
432
329
326
103
117
1,834
525
424
5.6%
EFTA01415991
312
316
107
78
1,762
593
430
329
328
106
99
1,886
2,225
1,726
1,312
1,293
417
411
7,385
2,290
1,753
1,387
1,355
405
365
7,555
2,394
1,849
1,421
1,431
425
376
7,897
8.9% 18.4% 9
.6% 3.5% 9.8% 2.3% 4.5%
19.7% 20.6% 19.1% 19.1% 17.6% 18.1% 15.8% 16.3% 17.9% 17.0% 17.1% 16.9%
12.6% 12.8% 13.2% 13.7% 13.2% 13.7% 13.0% 13.2% 13.0% 13.2% 13.1% 13.1%
15.4% 15.3% 15.2% 10.2% 8.7% 10.7% 9.9% 9
.7% 9.9% 10.0% 10.3%
9.3% 9.3% 8. 7% 9.2% 10.2% 10.1% 9.8% 9.8% 9.9% 9.9% 10.1% 10.1%
2.5% 2.6% 2. 7% 3.0% 3.1% 3.2% 3.1% 3.3% 3
.2% 3.2% 3.0% 3.0%
3.4% 2.8% 3. 0% 3.1% 3.0% 3.6% 3.5% 2.4% 3
.0% 3.1% 2.7% 2.7%
62.9% 63.4% 61.9% 58.2% 55.9% 59.4% 55.1% 54.7% 57.0% 56.5% 56.3% 55.7%
10.0%
64 bps
3,685
(52 bps) 148 bps
3,873
4,624
365 bps 237 bps
5,266
5,312
(42 bps)
EFTA01415992
1,303
(59 bps) (139 bps)
1,495
1,459
(32 bps)
1,425
(65 bps)
5,682
21 bps
5,863
58 bps
6,274
11.8% 5.1% 19.4% 13.9% 0.9% 7.1% 15.6% 3.7% 2.2% 7.0% 3.2% 7.0%
43.6% 28.7% 48.2% 134.6% N/A 35.5% 41.5% 25.1% 32.1% 35.9% 51.6% 54.6%
34
(342)
(308)
3,377
4
(357)
(353)
3,520
938
27
(371)
(344)
4,280
1,185
47
(439)
(392)
4,874
1,294
19
(480)
(461)
4,851
1,270
2
(122)
(120)
1,183
304
1
(123)
(122)
1,373
360
5
(119)
(114)
EFTA01415993
1,345
27.3% 26.6% 27.7% 26.5% 26.2% 25.7% 26.2%
921
356
2,456
224
2,680
$2.81
0.26
$3.06
871.1
875.4
2,582
30
2,612
$3.05
0.04
$3.09
843.1
846.1
3,095
72
3,167
$3.76
0.09
$3.85
819.2
823.5
3,580
(42)
3,538
$4.44
(0.05)
$4.39
800.7
805.1
3,581
59
3,640
$4.60
0.08
$4.67
776.0
779.2
879
5
884
$1.15
0.01
$1.16
761.3
26.5%
EFTA01415994
764.5
1,013
18
1,031
$1.34
0.02
$1.36
756.1
759.7
989
(31)
958
$1.31
(0.04)
$1.27
751.1
755.0
0
(121)
(121)
1,304
26.5%
346
959
959
$1.28
$1.28
746.7
750.6
8
(485)
(477)
5,205
0
(497)
(497)
5,366
26.2% 26.5%
1,366
1,422
3,840
(8)
3,832
$5.07
(0.01)
$5.06
753.8
757.4
3,944
EFTA01415995
$5.34
$5.34
734.0
737.9
3,944
4,245
11.9% 5.1% 19.9% 15.7% 0.0% 11.0% 17.1% 1.7% 0.7% 7.2% 2.7% 7.6%
$5.90
$5.90
16.2% 8.8% 23.2% 18.1% 3.5% 14.5% 21.1% 4.5% 3.8% 10.3% 5.4% 10.3%
716.2
720.1
0
(499)
(499)
5,776
26.5%
1,531
4,245
Deutsche Bank Securities Inc.
Page 67
EFTA01415996
31 October 2017
Railroads
Canadian Rails
Figure 126: CNI Balance Sheet
Canadian National Railway (CNI)
Annual Balance Sheet (C$ millions)
Assets
Current Assets:
Cash and cash equivalents
Restricted cash and cash equivalent
Accounts receivable, net
Materials and supplies
Deferred income taxes
Other current assets
Total Current Assets
Total properties (gross)
Less accumulated depreciation
Net property and equipment
Intangible assets
Other assets
Total Assets
Liabilities And Owner's Equity
Current Liabilities
Accounts payable and liabilities
Current portion of long term debt
Other
Total Current Liabilities
Long term Debt
Deferred income taxes
Other long-term liablities
Total Liabilities
Shareholder's Equity
Total Liabilities And Equities
2012
2012
2013
2013
2014
2014
2015
2015
2016
2016
2017
2017E
2018
2018E
2019
2019E
155
EFTA01415997
521
831
230
43
89
1,869
214
448
815
274
137
89
1,977
(10,579)
1,959
52
463
928
335
163
125
2,066
(11,195)
0
0
1,212
153
523
878
355
0
244
2,153
(12,203)
0
1,625
176
496
875
363
0
197
2,107
(12,412)
0
1,195
86
496
950
394
0
EFTA01415998
197
2,123
(13,438)
0
1,195
95
496
975
405
0
197
2,168
(14,176)
0
1,195
62
496
1,030
427
0
197
2,212
34,722 36,806 39,709 44,827 46,167 48,867 51,551 54,385
(10,181)
24,541 26,227 28,514 32,624 33,755 35,429 37,374 39,429
0
249
(14,956)
0
1,195
26,659 30,163 31,792 36,402 37,057 38,747 40,737 42,836
1,626
577
0
2,203
6,323
5,555
1,560
1,477
1,021
0
2,498
6,819
6,537
1,356
1,657
544
0
2,201
7,865
6,902
EFTA01415999
1,354
1,556
1,442
0
2,998
8,985
8,105
1,364
1,519
1,489
0
3,008
9,448
8,473
1,287
1,649
1,189
0
2,838
1,693
1,189
0
2,882
9,373
1,287
1,788
1,189
0
2,977
10,398 10,898 11,398
8,942
1,287
9,900
1,287
15,641 17,210 18,322 21,452 22,216 23,465 24,441 25,562
11,018 12,953 13,470 14,950 14,841 15,282 16,296 17,274
26,659 30,163 31,792 36,402 37,057 38,747 40,737 42,836
Page 68
Deutsche Bank Securities Inc.
EFTA01416000
31 October 2017
Railroads
Canadian Rails
Figure 127: CNI Cash Flow Statement
Canadian National Railway Company (CNI)
Annual Cash Flow Statement (C$ millions)
Operating Activities:
Net Income
Adjustments to reconcile net income
Depreciation and ammortization
Deferred income taxes
Net gain from disposal of investments
Net gain from disposal of property
Write down of investment
Other operating activities, net
Changes in working capital
Cash Flow From Operations
Investing Activities:
Capital investments
Proceeds from asset sales
Net capex
Acquisitions net of cash acquired
Disposal of properties
Disposal of investments
Other investing activities, net
Cash Flow From Investing
Financing Activities:
Issuance of LTD
Reduction of LTD
Net Issuance of commercial paper
Dividends paid
Issuance of common shares related to stock options
Repurchase of common stock
Issuance of convertible preffered security
Other financing activities, net
Cash Flow From Financing
Effect of foreign currency fluctuations
Cash and cash equivalents, beginning of period
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, end of period
2012
2012
2,680
924
451
0
(281)
0
(780)
66
EFTA01416001
3,060
(1,731)
0
(1,731)
0
311
0
(1)
(1,421)
493
(140)
(652)
117
(1,400)
0
0
(1,582)
(3)
101
54
155
2013
2013
2,612
980
331
0
(69)
0
(68)
(238)
3,548
(1,973)
0
(1,973)
0
52
0
69
(1,852)
1,582
(1,413)
268
(724)
31
(1,400)
0
0
(1,656)
19
155
EFTA01416002
59
214
2014
2014
3,167
1,050
416
0
(80)
0
(67)
(105)
4,381
(2,297)
0
(2,297)
0
173
0
(52)
(2,176)
1,022
(822)
(277)
(818)
30
(1,505)
0
0
(2,370)
3
214
(162)
52
2015
2015
3,538
1,158
600
0
0
0
0
(156)
5,140
(2,706)
0
(2,706)
0
0
0
EFTA01416003
(121)
(2,827)
841
(752)
451
(996)
79
(1,742)
0
(104)
(2,223)
11
52
101
153
2016
2016
3,640
1,225
704
0
(76)
0
(256)
(35)
5,202
(2,695)
0
(2,695)
0
85
0
(45)
(2,655)
1,509
(955)
137
(1,159)
61
(1,992)
0
(140)
(2,539)
15
153
23
672
2017
2017E
3,832
1,293
EFTA01416004
585
0
0
0
(250)
(24)
5,435
(2,700)
0
(2,700)
0
0
0
0
(2,700)
750
(100)
(300)
(1,240)
65
(2,000)
0
0
(2,825)
672
(90)
582
2018
2018E
3,944
1,355
617
0
0
0
(250)
(8)
5,658
(2,684)
0
(2,684)
0
0
0
0
(2,684)
500
0
0
(1,331)
65
EFTA01416005
(2,200)
0
0
(2,966)
582
8
591
2019
2019E
4,245
1,431
664
0
0
0
(250)
(18)
6,073
(2,834)
0
(2,834)
0
0
0
0
(2,834)
500
0
0
(1,436)
65
(2,400)
0
0
(3,271)
591
(33)
558
Deutsche Bank Securities Inc.
Page 69
EFTA01416006
31 October 2017
Railroads
Canadian Rails
Model updated: 25 October 2017
Running the numbers
North America
Canada
Railroads
Canadian National
Reuters: CNI.N
Sell
Price (30 Oct 17)
Target Price
52 Week range
Market cap (m)
Company Profile
Canadian National, headquartered in Montreal, Canada, provides
rail and intermodal freight transportation services over a 20,000
mile network connecting all four major ports in Canada (Prince
Rupert, Vancouver, Halifax & Montreal) to the Gulf of Mexico. In
2016, CNI generated C$12bn of revenue and $5.3bn of ebit.
USD 81.21
USD 73.00
USD 61.95 - 83.85
USDm 61,215
EURm 52,649
Income Statement (CADm)
Sales
EBITDA
EBIT
Pre-tax profit
Net income
Cash Flow (CADm)
Cash flow from operations
Net Capex
Free cash flow
Equity raised/(bought back)
Dividends paid
Price Performance
40
50
60
70
80
90
Jan '16
Margin Trends
35
40
45
50
EFTA01416007
55
60
14
15
Growth & Profitibility
10
15
20
-10
-5
0
5
14
Solvency
100
125
25
50
75
0
14
15
Seldon Clarke, CFA
16
Net debt/equity (LHS)
17E
18E
19E
Net interest cover (RHS)
10.5
11
11.5
12
12.5
13
15
16
17E
Sales growth (LHS)
18E
19E
ROE (RHS)
23.5
24
24.5
25
25.5
26
26.5
EFTA01416008
16
EBITDA Margin
17E
18E
EBIT Margin
19E
Jul '16
Canadian National
Jan '17
Jul '17
TSE Composite (Rebased)
Net inc/(dec) in borrowings
Other investing/financing cash flows
Net cash flow
Change in working capital
Balance Sheet (CADm)
Cash and cash equivalents
Property, plant & equipment
Goodwill
Other assets
Total assets
Debt
Other liabilities
Total liabilities
Total shareholders' equity
Net debt
Key Company Metrics
Sales growth (%)
DB EPS growth (%)
Payout ratio (%)
EBITDA Margin (%)
EBIT Margin (%)
ROE (%)
Net debt/equity (%)
Net interest cover (x)
DuPont Analysis
EBIT margin (%)
x Asset turnover (x)
x Financial cost ratio (x)
x Tax and other effects (x)
= ROA (post tax) (%)
x Financial leverage (x)
= ROE (%)
annual growth (%)
x NTA/share (avg) (x)
= Reported EPS
annual growth (%)
12,134
5,674
4,624
4,280
EFTA01416009
3,167
4,381
-2,297
2,084
-1,475
-818
-77
124
-162
-105
12,611
6,424
5,266
4,874
3,538
5,140
-2,706
2,434
-1,663
-996
540
-214
101
-156
12,037
6,537
5,312
4,851
3,640
5,202
-2,695
2,507
-1,931
-1,159
691
-85
23
-35
13,067
6,975
5,682
5,205
3,832
5,435
-2,700
2,735
-1,935
-1,240
350
0
-90
EFTA01416010
-24
13,418
7,218
5,863
5,366
3,944
5,658
-2,684
2,974
-2,135
-1,331
500
0
8
-8
14,171
7,706
6,274
5,776
4,245
6,073
-2,834
3,239
-2,335
-1,436
500
0
-33
-18
Bloomberg: CNI US
Fiscal year end 31-Dec
Financial Summary
DB EPS (CAD)
Reported EPS (CAD)
DPS (CAD)
BVPS (CAD)
Valuation Metrics
Price/Sales (x)
P/E (DB) (x)
P/E (Reported) (x)
P/BV (x)
FCF yield (%)
Dividend yield (%)
EV/Sales
EV/EBITDA
EV/EBIT
2014
3.76
3.85
1.00
16.44
EFTA01416011
2015
4.45
4.39
1.24
18.67
2016
4.60
4.67
1.49
19.13
2017E
5.07
5.06
1.64
20.27
2018E
5.34
5.34
1.81
22.20
2019E
5.90
5.90
1.99
24.12
4.7
18.6
18.1
4.9
3.6
1.4
5.4
11.5
14.1
5.0
17.7
17.9
4.2
3.9
1.6
5.8
11.3
13.8
5.2
17.7
17.4
4.7
4.0
1.8
6.1
11.2
EFTA01416012
13.8
6.0
20.6
20.6
5.1
3.5
1.6
6.9
12.8
15.8
5.9
19.5
19.5
4.7
3.9
1.7
6.7
12.5
15.4
5.5
17.7
17.7
4.3
4.3
1.9
6.4
11.8
14.4
52
28,514
0
3,226
31,792
8,409
9,913
18,322
13,470
8,357
14.7
23.2
25.8
46.8
38.1
24.0
62.0
12.5
153
32,624
0
3,625
36,402
EFTA01416013
10,427
11,025
21,452
14,950
10,274
3.9
18.3
28.2
50.9
41.8
24.9
68.7
12.0
176
33,755
0
3,126
37,057
10,937
11,279
22,216
14,841
10,761
-4.6
3.4
31.8
54.3
44.1
24.4
72.5
11.1
86
35,429
0
3,232
38,747
11,587
11,878
23,465
15,282
11,501
8.6
10.3
32.4
53.4
43.5
25.4
75.3
11.7
95
37,374
EFTA01416014
0
3,268
40,737
12,087
12,354
24,441
16,296
11,992
2.7
5.4
33.8
53.8
43.7
25.0
73.6
11.8
62
39,429
0
3,345
42,836
12,587
12,975
25,562
17,274
12,525
5.6
10.3
33.7
54.4
44.3
25.3
72.5
12.6
38.1
0.4
0.9
0.7
10.2
2.3
24.0
10.0
16.0
3.85
24.6
41.8
0.4
0.9
0.7
10.4
EFTA01416015
2.4
24.9
3.9
17.6
4.39
14.3
44.1
0.3
0.9
0.8
9.9
2.5
24.4
-1.9
19.1
4.67
6.3
43.5
0.3
0.9
0.7
10.1
2.5
25.4
4.1
19.9
5.06
8.3
43.7
0.3
0.9
0.7
9.9
2.5
25.0
-1.8
21.4
5.34
5.7
44.3
0.3
0.9
0.7
10.2
2.5
25.3
1.3
23.3
5.90
10.3
Page 70
EFTA01416016
Deutsche Bank Securities Inc.
EFTA01416017
31 October 2017
Railroads
Canadian Rails
Model updated: 24 October 2017
Running the numbers
North America
Canada
Railroads
Canadian Pacific
Reuters: CP.N
Buy
Price (30 Oct 17)
Target Price
52 Week range
Market cap (m)
Company Profile
Canadian Pacific, headquartered in Calgary, Canada, provides rail
and intermodal freight transportation services over 12,000 route
miles spanning six Provinces in Canada and 13 states in the U.S.
Its network consists of four primary corridors: Western, Eastern,
Central, and the Northeast United States In 2016, the company
generated C$6.2bn of revenue and C$2.6bn of EBIT.
Price Performance
200
125
150
175
100
75
Jan '16
Margin Trends
30
35
40
45
50
55
60
14
15
Growth & Profitibility
10
-10
-5
0
5
14
Solvency
100
150
200
EFTA01416018
50
0
14
15
Seldon Clarke, CFA
16
Net debt/equity (LHS)
17E
18E
19E
Net interest cover (RHS)
5
6
7
8
9
15
16
17E
Sales growth (LHS)
18E
ROE (RHS)
19E
15
20
25
30
35
16
EBITDA Margin
17E
18E
EBIT Margin
19E
Jul '16
Canadian Pacific
Jan '17
Jul '17
TSE Composite (Rebased)
USD 174.7
USD 209.0
USD 139.33 - 177.61
USDm 25,418
EURm 21,861
Income Statement (CADm)
Sales
EBITDA
EBIT
Pre-tax profit
EFTA01416019
Net income
Cash Flow (CADm)
Cash flow from operations
Net Capex
Free cash flow
Equity raised/(bought back)
Dividends paid
Net inc/(dec) in borrowings
Other investing/financing cash flows
Net cash flow
Change in working capital
Balance Sheet (CADm)
Cash and cash equivalents
Property, plant & equipment
Goodwill
Other assets
Total assets
Debt
Other liabilities
Total liabilities
Total shareholders' equity
Net debt
Key Company Metrics
Sales growth (%)
DB EPS growth (%)
Payout ratio (%)
EBITDA Margin (%)
EBIT Margin (%)
ROE (%)
Net debt/equity (%)
Net interest cover (x)
DuPont Analysis
EBIT margin (%)
x Asset turnover (x)
x Financial cost ratio (x)
x Tax and other effects (x)
= ROA (post tax) (%)
x Financial leverage (x)
= ROE (%)
annual growth (%)
x NTA/share (avg) (x)
= Reported EPS
annual growth (%)
6,620
2,891
2,339
2,050
1,480
2,123
-1,397
726
EFTA01416020
-1,988
-244
588
668
-250
-124
6,712
3,215
2,620
2,245
1,352
2,459
-1,449
1,010
-2,744
-226
2,013
371
424
275
6,232
3,218
2,578
2,098
1,599
2,089
-1,066
1,023
-1,189
-255
-46
-19
-486
-55
6,543
3,407
2,747
2,271
1,893
2,385
-1,235
1,150
-1,000
-309
120
5
-34
11
6,831
3,643
2,960
EFTA01416021
2,492
1,832
2,716
-1,275
1,441
-1,115
-328
120
40
158
-10
7,265
3,945
3,226
2,743
2,016
2,983
-1,325
1,658
-1,300
-349
95
25
129
7
Bloomberg: CP US
Fiscal year end 31-Dec
Financial Summary
DB EPS (CAD)
Reported EPS (CAD)
DPS (CAD)
BVPS (CAD)
Valuation Metrics
Price/Sales (x)
P/E (DB) (x)
P/E (Reported) (x)
P/BV (x)
FCF yield (%)
Dividend yield (%)
EV/Sales
EV/EBITDA
EV/EBIT
2014
8.52
8.49
0.00
32.47
2015
10.09
8.40
0.00
EFTA01416022
30.01
2016
10.29
10.62
0.00
30.93
2017E
11.44
12.98
0.00
49.56
2018E
13.14
13.14
0.00
70.64
2019E
14.95
14.95
0.00
95.11
5.0
22.4
22.5
6.7
2.2
0.0
5.8
13.3
16.4
4.9
20.2
24.3
5.8
3.1
0.0
6.1
12.7
15.6
4.3
17.5
17.0
6.2
3.8
0.0
5.7
11.0
13.7
5.0
19.6
17.3
EFTA01416023
4.5
3.5
0.0
6.3
12.1
15.0
4.8
17.1
17.1
3.2
4.6
0.0
6.0
11.3
13.9
4.5
15.0
15.0
2.4
5.5
0.0
5.6
10.4
12.7
226
14,438
176
1,800
16,640
5,793
5,237
11,030
5,610
5,567
650
16,273
211
2,503
19,637
8,957
5,884
14,841
4,796
8,307
nm
na
0.0
43.7
35.3
26.4
99.2
EFTA01416024
8.3
1.4
18.5
0.0
47.9
39.0
26.0
173.2
6.6
164
16,689
202
2,166
19,221
8,684
5,911
14,595
4,626
8,520
-7.2
2.0
0.0
51.6
41.4
33.9
184.2
5.5
130
17,264
202
4,456
22,052
8,804
6,038
14,842
7,210
8,674
5.0
11.2
0.0
52.1
42.0
32.0
120.3
5.8
288
17,856
202
6,582
24,928
8,924
EFTA01416025
6,176
15,100
9,828
8,636
4.4
14.8
0.0
53.3
43.3
21.5
87.9
6.3
416
18,462
202
9,153
28,233
9,019
6,420
15,439
12,794
8,603
6.4
13.8
0.0
54.3
44.4
17.8
67.2
6.7
35.3
0.4
0.9
0.7
8.9
3.0
26.4
na
32.2
8.49
na
39.0
0.4
0.8
0.6
7.5
3.5
26.0
-1.5
32.3
EFTA01416026
8.40
-1.0
41.4
0.3
0.8
0.8
8.2
4.1
33.9
30.6
31.3
10.62
26.5
42.0
0.3
0.8
0.8
9.2
3.5
32.0
-5.8
40.6
12.98
22.2
43.3
0.3
0.8
0.7
7.8
2.8
21.5
-32.8
61.1
13.14
1.2
44.4
0.3
0.9
0.7
7.6
2.3
17.8
-17.1
83.9
14.95
13.8
Deutsche Bank Securities Inc.
Page 71
EFTA01416027
31 October 2017
Railroads
Canadian Rails
Appendix 1
Important Disclosures
*Other information available upon request
Disclosure checklist
Company
Canadian National
Canadian Pacific
Ticker
CNI.N
CP.N
Recent price*
81.21 (USD) 30 Oct 2017
Disclosure
NA
174.74 (USD) 30 Oct 2017 NA
*Prices are current as of the end of the previous trading session unless
otherwise indicated and are sourced from local exchanges via Reuters,
Bloomberg, and other vendors. Other
information is sourced from Deutsche Bank, subject companies, and other
sources. For disclosures pertaining to recommendations or estimates made on
securities other than the
primary subject of this research, please see the most recently published
company report or visit our global disclosure look-up page on our website at
http://gm.db.com/ger/disclosure/
DisclosureDirectory.eqsr. Aside from within this report, important conflict
disclosures can also be found at https://gm/db.com/equities under the
"Disclosures Lookup" and "Legal"
tabs. Investors are strongly encouraged to review this information before
investing.
Analyst Certification
The views expressed in this report accurately reflect the personal views of
the undersigned lead analyst about the subject
issuers and the securities of those issuers. In addition, the undersigned
lead analyst has not and will not receive any
compensation for providing a specific recommendation or view in this report.
Seldon Clarke
Historical recommendations and target price. Canadian National (CNI.N)
(as of 10/30/2017)
100.00
Current Recommendations
Buy
Hold
Sell
75.00
Not Rated
Suspended Rating
50.00
** Analyst is no longer at
EFTA01416028
Deutsche Bank
25.00
0.00
Jan '16
May '16
Sep '16
Date
Jan '17
May '17
Sep '17
Page 72
Deutsche Bank Securities Inc.
Security price
EFTA01416029
31 October 2017
Railroads
Canadian Rails
Historical recommendations and target price. Canadian Pacific (CP.N)
(as of 10/30/2017)
200.00
Current Recommendations
Buy
Hold
Sell
150.00
Not Rated
Suspended Rating
100.00
** Analyst is no longer at
Deutsche Bank
50.00
0.00
Jan '16
May '16
Sep '16
Date
Equity Rating Key
Buy: Based on a current 12- month view of total share-holder
return (TSR = percentage change in share price from current
price to projected target price plus pro-jected dividend yield )
we recommend that investors buy the stock.
Sell: Based on a current 12-month view of total share-holder
return, we recommend that investors sell the stock.
Hold: We take a neutral view on the stock 12-months out and,
based on this time horizon, do not recommend either a Buy
or Sell.
Newly issued research recommendations and target prices
supersede previously published research.
Equity rating dispersion and banking relationships
Jan '17
May '17
Sep '17
Deutsche Bank Securities Inc.
Page 73
Security price
EFTA01416030
31 October 2017
Railroads
Canadian Rails
Additional Information
The information and opinions in this report were prepared by Deutsche Bank
AG or one of its affiliates (collectively
"Deutsche Bank"). Though the information herein is believed to be reliable
and has been obtained from public sources
believed to be reliable, Deutsche Bank makes no representation as to its
accuracy or completeness. Hyperlinks to thirdparty
websites in this report are provided for reader convenience only. Deutsche
Bank neither endorses the content nor
is responsible for the accuracy or security controls of these websites.
7
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or is included or discussed in another communication (oral or written) from
a Deutsche Bank analyst, Deutsche Bank may
act as principal for its own account or as agent for another person.
Deutsche Bank may consider this report in deciding to trade as principal. It
may also engage in transactions, for its
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Opinions, estimates and projections constitute the current judgment of the
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EFTA01416031
strategies or ideas that reference catalysts
or events that may have a near-term or medium-term impact on the market
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inherently imprecise and a product of the analyst ' s
judgment. The financial instruments discussed in this
suitable for all investors and investors must make
their own informed investment decisions. Prices and availability of
financial instruments are subject to change without
notice and investment transactions can lead to losses as a result of price
fluctuations and other factors. If a financial
instrument is denominated in a currency other than an
change in exchange rates may adversely
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are current as of the end of the previous trading session, and are sourced
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The Deutsche Bank Research Department is independent of other business areas
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Legal tab.
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7
Page 74
Deutsche Bank Securities Inc.
changes or
at the sole
majority of reports are
not take into account
an offer or a
instruments
Target prices are
report may not be
investor's currency, a
EFTA01416032
31 October 2017
Railroads
Canadian Rails
Macroeconomic fluctuations often account for most of the risks associated
with exposures to instruments that promise
to pay fixed or variable interest rates. For an investor who is long fixed
rate instruments (thus receiving these cash flows),
increases in interest rates naturally lift the discount factors applied to
the expected cash flows and thus cause a loss.
The longer the maturity of a certain cash flow and the higher the move in
the discount factor, the higher will be the
loss. Upside surprises in inflation, fiscal funding needs, and FX
depreciation rates are among the most common adverse
macroeconomic shocks to receivers. But counterparty exposure, issuer
creditworthiness, client segmentation, regulation
(including changes in assets holding limits for different types of
investors), changes in tax policies, currency convertibility
(which may constrain currency conversion, repatriation of profits and/or the
liquidation of positions), and settlement issues
related to local clearing houses are also important risk factors to be
considered. The sensitivity of fixed income instruments
to macroeconomic shocks may be mitigated by indexing the contracted cash
flows to inflation, to FX depreciation, or to
specified interest rates — these are common in emerging markets. It is
important to note that the index fixings may -- by
construction -- lag or mis-measure the actual move in the underlying
variables they are intended to track. The choice of the
proper fixing (or metric) is particularly important in swaps markets, where
floating coupon rates (i.e., coupons indexed to
a typically short-dated interest rate reference index) are exchanged for
fixed coupons. It is also important to acknowledge
that funding in a currency that differs from the currency in which coupons
are denominated carries FX risk. Naturally,
options on swaps (swaptions) also bear the risks typical to options in
addition to the risks related to rates movements.
7
7
Derivative transactions involve numerous risks including, among others,
market, counterparty default and illiquidity risk.
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EFTA01416033
to buying or selling an option investors must review the "Characteristics
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EFTA01416034
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Page 75
EFTA01416035
31 October 2017
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and services. If this is not the case, or if You are an IRA or other retail
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EFTA01416036
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Page 76
Deutsche Bank Securities Inc.
EFTA01416037
31 October 2017
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construed as a recommendation to trade in such securities/instruments.
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EFTA01416038
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Copyright © 2017 Deutsche Bank AG
Deutsche Bank Securities Inc.
Page 77
EFTA01416039
David Folkerts-Landau
Group Chief Economist and Global Head of Research
Raj Hindocha
Global Chief Operating Officer
Research
Anthony Klarman
Global Head of
Debt Research
Michael Spencer
Head of APAC Research
Global Head of Economics
Paul Reynolds
Head of EMEA
Equity Research
Andreas Neubauer
Head of Research - Germany
International locations
Deutsche Bank AG
Deutsche Bank Place
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Sydney, NSW 2000
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Tel: (61) 2 8258 1234
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London EC2N 2EQ
United Kingdom
Tel: (44) 20 7545 8000
Deutsche Bank AG
Mainzer Landstrasse 11-17
60329 Frankfurt am Main
Germany
Tel: (49) 69 910 00
Deutsche Bank Securities Inc
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New York, NY 10005
United States of America
Tel: (1) 212 250 2500
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Filiale Hongkong
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1 Austin Road West,Kowloon,
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Tel: (852) 2203 8888
Deutsche Securities Inc.
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Chiyoda-ku, Tokyo 100-6171
Japan
Tel: (81) 3 5156 6770
EFTA01416040
Dave Clark
Head of APAC
Equity Research
Spyros Mesomeris
Global Head of Quantitative
and QIS Research
Steve Pollard
Head of Americas Research
Global Head of Equity Research
Pam Finelli
Global Head of
Equity Derivatives Research
EFTA01416041
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